A growing number of audit committees are finding themselves in charge of overseeing internal investigations, and some may be ill-prepared to take on the duty.

A recent report from EY and law firm Squire Sanders says more than 70 percent of all public companies undertake some kind of internal investigation. “With the enactment of the Dodd-Frank Act, the increase in whistleblower claims filed in its wake, and the downturn in the world economy, few public companies will escape the need to conduct an occasional internal investigation, and companies in certain sectors will face such activity on a recurring basis,” the report states.

With that growing number of investigations, companies have struggled with where in the organization they should originate and what departments should be involved in carrying them out, including legal, human resources, internal audit, compliance, and the audit committee. “We've seen an uptick in the frequency of internal investigations,” says Jeff Ferguson, a partner with EY's fraud investigation and dispute services practice and a co-author of the paper. “The audit committee is made up of people who are somewhat part-time in their role and maybe not necessarily the best equipped to handle a pretty intense, full-time investigation.”

Yet the movement to have the audit committee lead serious internal investigations has been gaining steam for several years, says Frank Placenti, a partner with Squire Sanders and also co-author of the report, based on a number of regulatory, legislative, and judicial actions. Federal sentencing guidelines, bribery and corruption crackdowns, case law, Dodd-Frank, and now some 3,000 or more whistleblower complaints taken to the Securities and Exchange Commission have given companies growing reason to conduct independent internal investigations, he says.

“One could debate whether a part-time committee of the board or the audit committee is the right body to undertake these kind of heavy investigations, but audit committees increasingly are being asked to do it,” Placenti says. “So they ought to know more about what's expected of them, what an internal investigation looks like, and how to handle it.”

Audit committees are certainly familiar with the investigation of financial misdeeds, whether focused on books and records problems, accounting issues, or allegations against management, says Dan Goelzer, a partner with Baker & McKenzie and a former member of the Public Company Accounting Oversight Board. “Today there's almost an expectation if a company has a reason to believe there's some kind of serious conduct involving material financial reporting or foreign corrupt practices that the audit committee will oversee the investigation,” he says. It's possible in addition that audit committees might be asked to handle other investigations such as trade sanction issues, related-party transactions, or perhaps product litigation.

Many times an investigation will end up in the hands of the audit committee because it might have an indirect effect on financials, says Ferguson. “A lot of investigations regardless of the subject matter have an impact on financials and disclosures,” he says. “I don't think there's a bright line that says audit committees will deal with just these matters and not the others.”

Holding Audit Committees Responsible

A stark message for audit committees about their duty to oversee internal investigations came more recently from the SEC, says Goelzer, in the form of some recent enforcements against audit committee members who were aware of allegations but didn't adequately pursue them. The SEC has had big words lately about their intention to pursue enforcement actions against gatekeepers, “and that seems to include audit committees,” he says.

“A lot of investigations regardless of the subject matter have an impact on financials and disclosures. I don’t think there’s a bright line that says audit committees will deal with just these matters and not the others.”

—Jeff Ferguson,

Partner,

EY

In one case, the SEC says Ivan Gothner, audit committee chair for AgFeed, learned of an elaborate accounting fraud to report false revenues from China operations but failed to investigate. In another case, Shirley Kiang, audit committee chair for L&L Energy, learned the company's financial statements were certified in the name of a CFO who didn't work for the company and turned down a job offer, yet subsequently signed those same statements herself. “People on audit committees have to be alert to situations where there should be an internal investigation, but not get half way through it and not follow through,” he says. “That's a risk that people have to be really alert to.”

Hoyt Stastney, a partner with law firm Quarles & Brady, says running internal investigations is not necessarily routine business for audit committees. “A lot of times they're not familiar with the process, and there's a lot of hand holding,” he says. “Very few audit committees are up-to-speed on what needs to be done even before one of these things raises its head. These are issues that audit committees would like to do a very thorough investigation on but also put to bed in a reasonable time period. Audit committees hope to never be in this position.”

Hatching a Plan

Still, with the reality of the growing need for internal investigations, audit committees would be wise to prepare themselves, Stastney says. At the board level, there should be a plan for what rises to the level of requiring an internal investigation, and who should handle it, he says. Audit committees should also keep a short list of firms and forensic accountants they can turn to if needed, who are independent of the company, meaning they're not already established as a provider of legal services to the company on some other matters.

WHAT TRIGGERS AN AC INVESTIGATION?

Below EY & Squire Sanders list common subjects and triggers for an audit committee investigation.

An internal investigation is sometimes initiated by the audit committee based upon its own concerns. More often, investigations are triggered by external factors, circumstances, or events. Common subjects of audit committee investigations include:

Improper accounting for business activities (e.g., manipulation of earnings), falsified books and records, stock option grant irregularities, etc.

Illegal payments to obtain business (e.g., government contracts, FCPA issues and commercial bribery)

Occupational misconduct, such as embezzlement or employee theft

Conflict-of-interest or related-party transactions

 

Sources: EY; Squire Sanders.

Audit committees should also have a process for securing evidence and assuring documents that might be needed in an investigation aren't purged in the routine course of business. “You have to put a stop to regular purges until you've got independent lawyers and forensic accountants on board,” he says.

Jonathan Feld, an attorney with law firm Dykema, says audit committees need a good understanding of where their interaction with legal counsel, whether inside the company or outside, is covered by attorney-client privilege. Case law has held different views on the extent to which in-house attorneys are giving business advice or legal advice, leading to different privilege outcomes, he says. “Having an attorney CCed on something, whether it's internal or external, doesn't guarantee privilege,” he says.

Ferguson says audit committees would be wise to take advantage of continuing education opportunities to gear up for the possibility of overseeing an internal investigation. “Audit committees are very finance and accounting focused,” he says. “Investigation skills may not necessarily be something that is normally sought after when putting together an audit committee.”

Many professional organizations that serve board members or audit committee members offer continuing professional or legal education that is focused on overseeing investigations, Ferguson says. “I know this is something audit committees hope they never have to face, but we're seeing many companies face it more and more,” he says. “It's definitely something that should be on the radar.”

Topics