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• Best Practice » Reporting » Audit Committee Best Practices » Audit Committee Members Qualifications » Audit Committee Members Qualifications

For Nasdaq and New York Stock Exchange companies, the audit committee must contain a minimum of three directors, each of whom is “independent” and financially literate.

Independence

A director is considered “independent” if he or she has no relationship to the company that would interfere with the exercise of independent judgment in carrying out his or her responsibilities. The following directors are not deemed to be independent and therefore may not serve on the company’s audit committee:

• current employees of the company or its affiliates;
• individuals who have been employees of the company or its affiliates in any of the prior three fiscal years;
• immediate family members of a person currently employed as an executive officer of the company or its affiliates or who has been employed in such a capacity within the past three fiscal years;
• directors who have had certain prohibited business relationships with the company in the prior three fiscalyears; and
• directors employed as executives of another entity where any of the company’s executives serve on that entity’s compensation committee (cross-compensation committee links).

Financial Literacy

In addition, each member of the audit committee must be able to read and understand fundamental financial statements, including the company’s balance sheet, income statement and statement of cash flows. At least one member of the audit committee must also have employment experience in finance or accounting, requisite professional certification in accounting or comparable experience or background with financial oversight responsibilities. These financial literacy requirements place the audit committee in a better position to supervise the company’s financial reporting processes.

Other Important Qualities

To be effective, audit committee members should also be:

• prepared to devote a significant amount of time to service on the audit committee;
• able, and willing, to inform themselves about the company and its industry so that they can thoughtfully and objectively analyze the company’s financial reporting processes, financial statements and financial disclosures; and
• willing to ask tough, probing questions of management, the internal audit department (if the company has one) and the independent auditors regarding these mattersand to be persistentin getting adequate answers to their questions.

Best Practices

The Board should evaluate the following additional considerations when determining how to increase audit committee member independence and financial literacy:

• implementing training and education programs to ensure that audit committee members remain current on recent accounting and finance developments;
• increasing the number of audit committee members to include more than the minimum number required by Nasdaq and the NYSE;
• prohibiting directors who are not considered “independent” from serving on the audit committee, even if permissible under “exceptional and limited” circumstances;
• avoiding the appearance of impropriety by making certain that no member of the audit committee has any business or family relationship with the company or its management team, other than as a director;
• distributing to potential audit committee members a written description of the best practices, qualifications, responsibilities and time commitments expected;
• considering whether it is advisable to limit the term of audit committee members;
• evaluating whether audit committee members are receiving an appropriate level of compensation given their responsibilities;
• evaluating whether the company’s charter, bylaws and director indemnification agreements provide adequate protections for audit committee members; and
• evaluating whether the company’s D&O insurance policy provides adequate coverage to audit committee members.

Further reading: Corporate Governance | Audit | Performance Improvement