Financial Reporting Council

Sir Robert Smith launches report on Audit Committees

FRC PN 70

20 January 2003

Following the major corporate failures in the US last year, the FRC was asked to set up an independent group to clarify the role and responsibilities of audit committees and to develop the existing Combined Code guidance. The role of audit committees in reinforcing the independence of the auditor was a major concern. Sir Robert Smith, Chairman of The Weir Group PLC and a member of the FRC, was invited to chair the group.

Sir Robert said: “The report I am publishing today develops and codifies the role of audit committees, building on current best practice. I believe its implementation will raise British corporate governance standards and help to maintain our position among the leaders in the field. The guidance we propose will strengthen the hand of audit committees without breaking the unitary board structure.”

The key points, to be reflected in the Combined Code and the detailed guidance, are:

Composition of the audit committee

Committee to include at least three members, all independent non-executive directors.
At least one member to have significant, recent and relevant financial experience, and suitable training to be provided to all

Role of the audit committee

To monitor the integrity of the financial statements of the company, reviewing significant financial reporting judgements;
To review the company’s internal financial control system and, unless expressly addressed by a separate risk committee or by the board itself, risk management systems;
To monitor and review the effectiveness of the company’s internal audit function;
To make recommendations to the board in relation to the external auditor’s appointment; in the event of the board’s rejecting the recommendation, the committee and the board should explain their respective positions in the annual report;
To monitor and review the external auditor’s independence, objectivity and effectiveness, taking into consideration relevant UK professional and regulatory requirements;
To develop and implement policy on the engagement of the external auditor to supply non-audit services, taking into account relevant ethical guidance regarding the provision of non-audit services by the external audit firm

In addition the Code will require that the committee should be provided with sufficient resources, that its activities should be reported in a separate section of the directors’ report (within the annual report) and that the chairman of the committee should be present to answer questions at the AGM.

Sir Robert added: “Once these proposals are reflected in the Code, a listed company that fails to comply will have to explain why in its annual report. I look forward with confidence to seeing the group’s recommendations endorsed by the FRC and incorporated definitively into the Code in the near future.”

Notes to Editors

The FRC set up the group at the request of the Co-ordinating Group on Audit and Accounting Issues (CGAA), the body established by the Government to oversee and co-ordinate the response in the UK to the issues raised by recent major corporate failures in the US.

FRC Press Notice 67 of 12 September announced the establishment of the Smith group. The members of the group were:

Mark Armour Chief Financial Officer, Reed Elsevier PLC
Ted Awty Chairman, Client Service Board, KPMG
Glyn Barker Head of Audit and Business Advisory Services, PwC
Richard Delbridge Formerly Group Chief Financial Officer, NatWest Group
Richard Fleck Partner, Herbert Smith and Chairman, Auditing Practices Board
David Rough Formerly Group Director (Investments), Legal & General

FRC Press Notice 71 of today announces the FRC’s response to the Smith report and to the Higgs report “Review or the role and effectiveness of non-executive directors”, also published today. Both reports propose changes to the Combined Code on Corporate Governance, and it is for the FRC to decide on those proposals.

The Smith report “Audit committees: Combined Code guidance” and both Press Notices and are available on the FRC’s website www.frc.org.uk. Hard copies are also available free of charge from the Financial Reporting Council, Holborn Hall, 100 Gray’s Inn Road, London WC1X 8AL, telephone 020 7611 9710.

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Press Enquiries: Charles Bridge, Assistant Secretary FRC, on 020 7611 9706.