R. Todd Johnson,

Partner in Charge

Jones Day Menlo Park

January 17,2003

The New Audit Committee -- Risks, Realities and Responses

A Quick Primer

A Few Defined Concepts

Financial Expert

• Person with the following attributes:– understanding of financial statements and GAAP;– ability to assess application of such principles in

accounting for estimates, accruals and reserves;– experiencing preparing, auditing, analyzing or

evaluating generally comparable statements;– understanding of internal controls and procedures

for financial reporting; AND– an understanding of audit committee functions.

Financial Expert

• Person can acquire such attributes through:– education and experience as a principal financial

officer, principal accounting officer, controller, public accountant or auditor;

– experience actively supervising one of the above or experience overseeing or assessing the performance of companies or public accountants with respect to the preparation, auditing or evaluation of financial statements; or

– other relevant experience.

Prohibited Non-Audit Services• Bookkeeping/Accounting-related services• Financial info system design/implementation• Appraisal/Valuation/Fairness opinions • Actuarial services• Internal audit outsourcing• Management/HR functions• Broker-dealer/investment advisor/investment banking• Legal services/expert services unrelated to audit• Any service prohibited by PCAOB

Test for Unlisted Prohibited Non-Audit Services

• Public company auditor should not:– audit its own work– function as management or an employee of

audit client– promote or advocate client’s stock or financial

interest.

A “Special Deal” for Tax Services

• SarBox permits “tax services,” SEC’s proposed regulations limit role to tax preparation and would prohibit:– representation before tax court (IRS?)– formulation of tax strategies (e.g., tax shelters)

designed to minimize a company’s tax obligations.

Required Reports from Auditor to Audit Committee

• All critical accounting policies and practices of the issuer.

• All alternative accounting treatments within GAAP that were discussed with management, including:– ramifications of using each alternative;– treatment preferred by the auditor

Required Reports from Auditor to Audit Committee

• Other material -- written communications between auditor and management

SEC Rules on Attorney Conduct

• Becoming aware of evidence of a material violation by issuer, officer, director, agent or employee;

• Report evidence to:– Chief legal officer or CEO;– CEO;– Audit committee/independent director’s

committee/full board OR– Qualified Legal Compliance Committee

SEC Rules on Attorney Conduct

• “Material Violation” - violations of securities laws, breaches of fiduciary duties, or similar material violations about which reasonable investors would want to know

• If no “appropriate response,” then noisy withdrawal

SEC Rules on Attorney Conduct

• “Appropriate Response” -- provides basis for attorney to believe:– No violation has occurred, is occurring or

will occur;– issuer adopted appropriate remedial

measures, including disclosures and/or sanctions expected to stop ongoing and future violations and rectify past ones.

QUESTIONS TO ASK BEFOREHAND

1. Do I qualify?

2. What are the risks?

3. Is this a full-time job?

Do I Qualify?

• Independence

— affiliations

— compensation

• Financial expertise

— education

— experience

• Other audit committee commitments

What are the risks?

• No change in fiduciary duties or standards

of liability

YET

• über class of directors

• confirm indemnity and insurance

Is this a full-time job?

NO• Oversight

• Delegation

• Control of the Agenda

• Follow-up

Areas of Focus

• Revenue recognition

• Expense avoidance or deferral

• Off-balance sheet financing

• Acquisition accounting

• Equity transactions

• E.B.B.S.— Earnings Before Bad Stuff (Pro Forma)

Control the Agenda

Ten Questions to Put in Your Pocket and Use Now

Ten Key Questions

1. What issues took most of your time

and attention this period?

2. In what financial areas would you

describe the company as aggressive?

Conservative?

Ten Key Questions

3. Did anyone advocate more aggressive or

conservative treatment on these issues?

How were they resolved?

4. What are the most significant judgment

calls you have made this period? With

more resources and time, what would you

do differently?

Ten Key Questions

5. If the SEC were reviewing the company's financials, what issues would most likely receive close scrutiny?

6. How do your industry peers handle these issues?

7. Are there any accounting policies that, in the layman's view, distort the earnings cycle or mask business trends?

Ten Key Questions

8. Does the most recent MD&A describe,

clearly and accurately, the company’s

critical accounting policies and all off-

balance sheet items and material

commitments?

Ten Key Questions

9. Are there any unresolved matters or

pending circumstances whose resolution

could be significant to the company?

Ten Key Questions

10. How would you characterize the quality

of the company’s internal and accounting

controls? Does the company need more

or better resources to handle its financial

reporting obligations, including internal

audit personnel?

Advice from auditors? $Advice from lawyers? $$

Advice from bankers? $$$

Aggressive questions from you?

Priceless