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Many boards establish committees to focus on specific subject matters (e.g., audit, governance, investments). The time and effort required of mutual fund directors, especially independent directors, have grown exponentially as the industry has increased in size and complexity and as new regulations have expanded directors’ duties. In this environment, boards frequently use both standing and ad hoc committees to help manage their workloads and to enable greater in-depth review and oversight of particular topics or aspects of the fund’s operations.

Audit Committees

A mutual fund board audit committee is responsible, among other things, for overseeing the accounting and financial reporting processes of the fund and its internal controls over financial reporting. In this context, the audit committee recommends to the full board (and shareholders, where a shareholder is sought) the selection of independent auditors for the investment company and meets periodically with the auditors.

did you know
Virtually every mutual fund’s audit committee is composed entirely of independent directors. This has been adopted as a best practice even though funds are not required to do so unless relying on certain SEC rules.

Meetings with the auditors help the committee:

  • review the arrangements for and the scope of the annual audit of the fund’s financial statements, and
  • consider any comments the auditors have in connection with their audit and their audit opinion.

An audit committee also often monitors management’s accounting and internal control systems for the funds.

The Sarbanes-Oxley Act

The Sarbanes-Oxley Act of 2002 places a number of requirements on fund board audit committees. For example, to minimize potential conflicts of interest, audit committees must preapprove any audit or permitted “non-audit” services provided to the fund, as well as any permitted non-audit services provided to the fund’s investment adviser and certain affiliates of the adviser where the nature of the services provided relates directly to the operations and financial reporting of the fund. The Sarbanes-Oxley Act also requires the timely reporting of specific information by auditors to audit committees.

Audit Committee Financial Experts

Each fund board is required to determine whether any member(s) of the audit committee are “audit committee financial experts” as defined by SEC rule. Although a fund board is not required to have an audit committee financial expert, it is required to disclose whether it has one, and if so, the name of the expert and whether the expert is independent of management. A fund that does not have an audit committee financial expert must disclose this fact and explain why it has no such expert. 

did you know
Ninety-five percent of fund complexes participating in IDC/ICI’s Directors Practices Study report having a financial expert on the audit committee.

The SEC has tried to clarify that the designation of a person as an audit committee financial expert does not impose on that person any duties, obligations, or liabilities under the federal securities laws that are greater than those imposed on the person as a member of the audit committee and board. This clarification, however, does not have the force of law and whether the fund audit committee financial expert designation does, in fact, invite greater scrutiny remains an open question.