A close reading of the Federal Deposit Insurance Corp.'s proposed rule on "Annual Independent Audits and Reporting Requirements" suggests that the consequences of these provisions will be more far-reaching than has generally been realized and that banks should take steps to ensure compliance before the end of 1992.
The proposed regimen is simple and harmless-sounding. All banks with more than $150 million of assets would have to be audited by independent accountants who meet certain standards. These accountants would also evaluate the bank's controls.
Management would have to file an annual report with federal regulators stating its responsibility for financial statements, evaluating controls, and commenting on compliance with the law.
The accountants would then apply specific tests to management's assertions and report on the results of those tests. And the bank's audit committee, which must be independent, would review management's report and the accountants' reports.
Banks with more than $500 million in assets also would have to make independent counsel available to the audit committee, and audit committee members would have to meet a few additional tests. But the devil is in the details.
One of the important details is that although the stated effective date is for fiscal years after Dec. 31, 1992 - which might suggest that nothing has to be done until the 1993-94 audit season - the management report that will have to be filed early in 1994 will have to speak about various compliance issues for all of 1993, and the accountants will have to test those assertions against activities during the whole year.
Written Policies
In addition, the appendix to the proposed rule, which sets out the tests the auditors are to Perform, makes it clear that the bank's written policies are the first thing to be tested. For this reason, acceptable policies must be in place by the beginning of 1993.
Nor can the independent accountant be expected to assist management in smoothing over potential issues. Under the proposed rule, the accounting firm is not "independent" if it participates in any way in helping management prepare its annual report.
Moreover, the accounting firm must describe in its report any differences that it finds from management's "assertions." Also, the accounting firm's work papers must be made available to the FDIC upon request.
Documents Are Public
This is not just a question of relationships with the regulatory authorities. The entire management report, including management's own evaluation of the bank's controls and its compliance with laws, and the accountants' report, are public documents.
Because of this structure, a review of the relevant policies and practices before yearend 1992 would be warranted in order to minimize the possibility of embarrassment (or worse) in 1994.
Early action is also recommended because, although the proposed rule does not require that auditors (and audit committees) review quarterly financial statements for publicly held banks or holding companies (as the statute would have permitted), it does require that independent accountants perform tests with respect to the quarterly call reports.
These tests may be performed in connection with the yearend audit, but many banks will not want their call reports to be second-guessed months after they have been filed. Civil money penalties can be based on time elapsed until correction.
The proposed rule also says that "the audit committee's duties may include, but not necessarily be limited to" a series of areas, including "reviewing call reports, or in the case of savings associations, thrift financial reports, for accuracy and timeliness."
This function is not said to be mandatory, but the list is short enough that an audit committee will need a very good reason not to perform in all of the suggested areas.
And again, if can reports are to be reviewed, it is better to review them sooner rather than later, which puts the audit committee to work reviewing call reports at the end of the first quarter of 1993.
Two future articles on this subject will focus on the management issues and audit committee issues separately.
