2005 Audit Committee Charter
In furtherance of the requirements and responsibilities assigned to the Audit Committee (or Committee) at Article IX, Section 5 of the By-Laws (see Exhibit I), this Charter governs the operations of the Audit Committee. The Charter will be reviewed and reassessed, at least annually, by the Committee and will be approved by the Board of Governors. The Committee shall be appointed by the Board of Governors and shall consist of four or five Governors; each of who are independent of management and NASD1, as The Securities and Exchange Commission (SEC) defines the term independent director2. All Committee members will be able to read and understand fundamental financial statements, including a balance sheet, income statement, and cash flow statement. The Committee shall designate, subject to Board approval, at least one of its members as the “audit committee financial expert” (see Exhibit II).
Statement of Policy
The Audit Committee will assist the Board of Governors in fulfilling the Board’s oversight responsibilities to the members and the public in the following areas:
- The compliance with legal and regulatory programs, and ethics programs established by management and the Board,
- The internal audit function,
- The systems of internal accounting and financial controls,
- The independence and performance of the IPA, and
- NASD's financial statements and the financial reporting process.
In so doing, it is the responsibility of the Committee to maintain free and open communication among the Committee, independent auditors, internal auditors, and management of NASD. In discharging its oversight role, the Committee is empowered to investigate any matter brought to its attention with full access to all books, records, facilities, and personnel of NASD and the authority to retain outside counsel, or other experts, for this purpose.
Responsibilities and Processes
In fulfilling these responsibilities, the Audit Committee shall perform the following recurring activities. In carrying out its responsibilities, the Committee’s policies and procedures should remain flexible, in order to best react to changing conditions and circumstances. The Committee shall report at least quarterly to the Board of Governors on the performance of these activities.
Compliance with Legal, Regulatory, and Ethics Programs
- Discuss with management, the internal auditors, and the IPA the adequacy and effectiveness of programs for ensuring legal and ethical compliance.
- Review the activities of and consult with the NASD Ombudsman, particularly in circumstances in which management does not adequately respond to actions suggested by the Ombudsman.
- Receive from, and discuss with, management, at least quarterly, a report of regulatory examination activities and the results reported from such activities, including management’s proposed corrective actions.
- Receive reports from the internal auditors on the results of monitoring and follow-up on implementation of management’s corrective actions in response to regulatory examination reports.
- Receive from management, at least annually, a report on ethics programs, to include administration of the programs, proposed changes to policy for the Committee’s approval, and a summary of violations and corrective actions.
- Conduct an appropriate review of all related party transactions3 for potential conflict of interest situations and approve all such transactions before NASD enters into the transaction.
- Establish procedures for handling complaints regarding accounting, internal accounting controls, or auditing matters, and ensure that any such complaints are appropriately investigated.
The Internal Audit Function
- Direct and oversee the activities of the organization's internal audit function to ensure the existence of a substantial, independent internal audit staff, which reports directly to the Audit Committee and reviews all aspects of the NASD and its subsidiaries, including the regulatory and the disciplinary processes, and NASD’s, and its subsidiaries’, systems. (See Exhibit III, Delegation of Functions From the Audit Committee to Senior Management with Regard to the Operations of the Internal Audit Department.)
- Review and approve, at least annually, the Internal Audit Charter and the authority provided to the Internal Audit Department.
- Review and approve, at least annually, proposed internal audit plans for the coming year, the department budget and staff; significant interim changes to the plans, budget, or staffing; and the coordination of such plans with those of the independent auditors.
- Ensure the internal audit function’s compliance with the Institute of Internal Auditors' Standards for the Professional Practice of Internal Auditing.
- Meet separately with the internal auditors, at least quarterly, to discuss matters as necessary to ensure that internal audit has the resources and management support necessary to effectively perform its duties.
The Systems of Internal Accounting and Financial Controls
- Discuss with management, the internal auditors, and the IPA the adequacy and effectiveness of the accounting and financial controls, including NASD's system for monitoring and managing business risk.
- Receive periodic reports from management on the quality of internal controls in key risk and control areas (e.g., information technology environment, insurable risk management).
- Receive summary reports from the internal auditors on the results of internal audits and management’s progress in responding to issues identified, and discuss with management any disagreements on the issues or delays in taking corrective actions.
The Independence and Performance of the IPA
- Establish a clear understanding with management, and the IPA, that the IPA is ultimately accountable to the Board and the Audit Committee, and that the Audit Committee has the ultimate authority and responsibility to evaluate and, where appropriate, replace the IPA.
- Discuss the IPA’s independence from management and NASD and the matters included in the written disclosures required by the Independence Standards Board.
- Annually, review and recommend to the Board the selection of NASD’s IPA.
- Set clear hiring policies for employees or former employees of the IPA.
- Set and follow policies for review and approval of all IPA services and fees, where such policies meet relevant requirements set by the SEC for public traded companies.
NASD's Financial Statements and the Financial Reporting Process
Management is responsible for preparing NASD's financial statements, and the independent public accountant (IPA) is responsible for auditing those financial statements.
- Take the appropriate actions to set the overall corporate "tone" for quality financial reporting, sound business risk management practices, and ethical behavior.
- Oversee NASD's financial reporting process on behalf of the Board and report the results of these activities to the Board.
- Review and discuss with management, and the IPA, the audited financial statements of NASD, or its subsidiaries, including their judgment about the quality, not just acceptability, of accounting principles, the reasonableness of significant judgments, and the clarity of the disclosures in the financial statements.
- Discuss the results of the annual audit and any other matters required to be communicated to the Committee by the IPA under generally accepted auditing standards.
- Review with management and the IPA (if they have reviewed unaudited financial statements), any unaudited financial statements prepared for external distribution, before distribution or publication of such financial statements. (The Chair of the Committee may represent the entire Committee for the purposes of this interim review.)
- Discuss any other matters that the IPA is required to communicate to the Committee under generally accepted auditing standards, in connection with a financial statement audit.
- Meet with the independent auditors, with and without management present, to discuss the results of their annual audit.
- Prepare an audit committee report, consistent with such reports required by the SEC to be included in annual proxy statements for public companies, for inclusion in NASD’s annual report.
- Make a recommendation to the Board of Governors for approval of the financial statements for publication in NASD’s Annual Report.
Exhibit I – By-Laws of The National Association of Securities Dealers, Inc.
Article IX, Section 5
(a) The Board shall appoint an Audit Committee. The Audit Committee shall consist of four or five Governors, none of whom shall be officers or employees of the Association. A majority of the Audit Committee members shall be Non-Industry Governors. The Audit Committee shall include two Public Governors. A Public Governor shall serve as Chair of the Committee. An Audit Committee member shall hold office for a term of one year.
(b) The Audit Committee shall perform the following functions: (i) ensure the existence of adequate controls and the integrity of the financial reporting process of the NASD; (ii) recommend to the NASD Board, and monitor the independence and performance of, the certified public accountants retained as outside auditors by the NASD; and (iii) Direct and oversee all the activities of the NASD’s internal review function, including but not limited to management’s responses to the internal review function.
(c) No member of the Audit Committee shall participate in the consideration or decision of any matter relating to a particular NASD member, company, or individual if such Audit Committee member has a material interest in, or a professional, business, or personal relationship with, that member, company, or individual, or if such participation shall create an appearance of impropriety. An Audit Committee shall consult with the General Counsel of the NASD to determine if recusal is necessary. If a member of the Audit Committee is recused from consideration of a matter, any decision on the matter shall be by a vote of a majority of the remaining members of the Audit Committee.
(d) The Audit Committee shall have exclusive authority to: (i) hire or terminate the Director of Internal Review; (ii) determine the compensation of the Director of Internal Review; and (iii) determine the budget for the Office of Internal Review. The Office of Internal Review and the Director of Internal Review shall report directly to the Audit Committee. The Audit Committee may, in its discretion, direct that the Office of Internal Review also report to senior management of the NASD on matters the Audit Committee deems appropriate and may request that senior NASD management perform such operational oversight as necessary and proper, consistent with preservation of the independence of the internal review function.
(e) At all meetings of the Audit Committee, a quorum for the transaction of business shall consist of a majority of the Audit Committee, including not less than 50 percent of the Non-Industry committee members. In the absence of a quorum, a majority of the committee members present may adjourn the meeting until a quorum is present.
Exhibit II – Definition of Audit Committee Financial Expert
The definition of Audit Committee Financial Expert, as it appears in the Standard Instructions for Filing Forms under the Securities Act of 1933, Securities Exchange Act of 1934 and … Regulation S-K, is stated as follows:
Item 401 -- Directors, Executive Officers, Promoters and Control Persons
- …, an audit committee financial expert means a person who has the following attributes:
- An understanding of generally accepted accounting principles and financial statements;
- The ability to assess the general application of such principles in connection with the accounting for estimates, accruals and reserves;
- Experience preparing, auditing, analyzing or evaluating financial statements that present a breadth and level of complexity of accounting issues that are generally comparable to the breadth and complexity of issues that can reasonably be expected to be raised by the registrant's financial statements, or experience actively supervising one or more persons engaged in such activities;
- An understanding of internal control over financial reporting; and
- An understanding of audit committee functions.
- A person shall have acquired such attributes through:
- Education and experience as a principal financial officer, principal accounting officer, controller, public accountant or auditor or experience in one or more positions that involve the performance of similar functions;
- Experience actively supervising a principal financial officer, principal accounting officer, controller, public accountant, auditor or person performing similar functions;
- 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.
- Safe Harbor.
- A person who is determined to be an audit committee financial expert will not be deemed an expert for any purpose, including without limitation for purposes of section 11 of the Securities Act of 1933, as a result of being designated or identified as an audit committee financial expert pursuant to this Item 401.
- The designation or identification of a person as an audit committee financial expert pursuant to this Item 401 does not impose on such person any duties, obligations or liability that are greater than the duties, obligations and liability imposed on such person as a member of the audit committee and board of directors in the absence of such designation or identification.
- The designation or identification of a person as an audit committee financial expert pursuant to this Item 401 does not affect the duties, obligations or liability of any other member of the audit committee or board of directors.
Exhibit III - Delegation of Functions From the Audit Committee to Senior Management with Regard to the Operations of the Internal Audit Department
The following represents the delegation of functions from the Audit Committee to Chairman and Chief Executive Officer (CEO) and, where appropriate, to those the CEO designates as Senior Management of NASD with regard to the operation of the Internal Audit Department, as discussed and approved by the Audit Committee on April 22, 2004.
The Audit Committee shall direct and oversee all the activities of NASD’s internal audit function, including but not limited to management’s responses to the internal audit function. Further, Internal Audit shall report directly to the Audit Committee, which may then, at its discretion, direct that the department also report to senior management of NASD on appropriate matters. In addition, the Audit Committee may request that senior management perform operational oversight as necessary and proper, consistent with preservation of the independence of the internal audit function. The purpose of this memorandum is to set out the scope of Audit Committee oversight of Internal Audit, as well as the delegation of other functions to senior management.
Audit Committee Oversight
- According to the By-laws, the Audit Committee has exclusive authority to hire, terminate, and determine the compensation of the Senior Vice President of Internal Audit.
- The Audit Committee has exclusive authority to determine the budget for the Internal Audit Department.
- The Institute of Internal Auditors’ Standards for the Professional Practice of Internal Auditing ("IIA Standards") recommends that internal audit departments submit activity reports to the Audit Committee and senior management annually, highlighting audit findings that may adversely affect the organization. According to the IIA, significant audit findings may include dealing with irregularities, illegal acts, errors, inefficiency, waste, ineffectiveness, conflicts of interest, and control weaknesses.
- The NASD's Internal Audit Department submits periodic activity summaries to the Audit Committee in the form of status reports that highlight audit findings, as well as management responses. Internal Audit prepares these summaries in anticipation of Audit Committee meetings, which will occur at least four times per year, and will maintain that schedule rather than summarizing activities annually; and will make copies of all Internal Audit reports available to the Audit Committee upon request.
- Internal Audit also maintains close relationships with the Chairperson of the Audit Committee, notifying him of material irregularities, as they are uncovered, with follow-up reports discussed at Audit Committee meetings. Internal Audit will notify the Chairperson of the Audit Committee when any material breach of controls, illegal acts, significant irregularities, or employee improprieties occur, with follow-up at the full committee level.
- The IIA recommends that the Audit Committee review the annual Internal Audit plan and be informed of any significant changes to the plan. Internal Audit submits the audit plan to the committee for its review and approval, and provides a discussion of any significant modifications to the plan in status reports. Internal Audit will also provide interim updates to the Chairperson as warranted.
- The IIA emphasizes the importance of direct and unrestricted access between the Audit Committee and Internal Audit. To accomplish this objective, the Audit Committee will meet separately with the SVP of Internal Audit in Executive Session at each Audit Committee meeting.
Delegation to the CEO
- Day-to-day oversight of the operation of the Internal Audit Department is delegated to the CEO of NASD (or an officer specifically designated by the CEO), to include approval of budgeted expenses, requisitions, and contracts, if such exceed the signing authority of SVP of Internal Audit. Review and approval of intra-year budget variances or changes to the budget are delegated to the CEO of NASD, subject to the consent of the Committee or the Committee Chairperson.
Assistance by Senior Management of NASD and Its Related Entities
- Senior Management will receive and review all audit reports prepared by Internal Audit; discuss the recommendations made and management responses; and support implementation of the accepted recommendations.
- Senior Management will provide full support to Internal Audit’s requests, including free and unrestricted access to all company functions, records, property, and personnel in order to perform its audit and review functions.
- Because Internal Audit does not have direct authority over the personnel and departments it evaluates, Internal Audit relies on the active support of Senior Management in requiring prompt and comprehensive responses from department management to reports of findings and recommendations.
- Internal Audit regularly reports to Senior Management on the status of recommendations not yet implemented and relies on management assistance in securing such implementation.
- Senior Management will refer items to Internal Audit for investigation, and has the authority to re-prioritize the workload of the department should these "cause investigations" necessitate such action, subject to the consent of the Committee or the Chairperson.
1 Industry directors are not disqualified from serving on the Audit Committee solely because they are an employee or officer of a member firm, as long as they are not subject to one or more of the disqualifying situations as identified in Rule 10A-3.
2 SEC Rule 10A-3 under the 34 Act, Listing Standards Relating to Audit Committees, sets two criteria for director independence, as follows:
- The first is that audit committee members are barred from accepting any consulting, advisory or other compensatory fee from [NASD or any affiliate], other than in the member's capacity as a member of the board of directors and any board committee. This prohibition will preclude payments to a member as an officer or employee, as well as other compensatory payments.
- The second basic criterion for determining independence is that a member of the audit committee … may not be an affiliated person of [NASD or an affiliate] apart from his or her capacity as a member of the board and any board committee.
3 SEC Regulation S-K, Item 404 requires disclosure of transactions of the following types (with more extensive definition available from the regulation):
- Transactions with management and others (i.e., directors or executive officers, nominees for election as director, any security holder owning > 5% of the voting stock, or an immediate family member of the foregoing)
- Certain business relationships with directors or director nominees
- Indebtedness of management
- Transactions with “promoters”