Companies on NASDAQ: Get Ready for New Proposed Internal Audit Rule

The NASDAQ recently proposed a rule that companies listed on the stock exchange will soon be required to establish and maintain an internal audit department. In response, the Securities and Exchange Commission (SEC) is in the process of circulating the proposal and gathering public comments. The comment period ends shortly on March 29, 2013.

If the proposal results in a rule change, companies currently listed on the exchange must establish an internal audit function no later than December 31, 2013. For companies that plan to list on NASDAQ after June 30, 2013, they must implement the internal audit function before they can list on the exchange.

The proposed rule includes the following key points:

1.      Each company must establish and maintain an internal audit function to provide management and the audit committee with ongoing assessments of the company’s risk management processes and system of internal control.

2.      The company may choose to outsource this function to a third party service provider other than its independent auditor.

3.      The audit committee must meet periodically with the internal auditors (or other personnel responsible for this function) and assist the board in its oversight of the performance of this function.

4.      The audit committee should also discuss with the outside auditor the responsibilities, budget, and staffing of the internal audit function.

NASDAQ states that the “purpose of the rule is to ensure that listed companies have a mechanism in place to regularly review and assess their systems of internal control and, thereby, to identify any weaknesses and develop appropriate remedial measures.”

Given the aggressive timeline associated with this proposal, and the likelihood that it will become a requirement, companies listed on NASDAQ, as well as companies that plan to list after June 30, 2013 must consider how best to comply with it.

Before creating an internal audit department, ask the following three questions:

1.      What will an internal audit do? Notwithstanding the need to comply with NASDAQ’s rule change, creating an internal audit function without a clear understanding of the department’s role could be costly and largely unproductive. Take the time to identify and document the department’s charter, goals, and objectives. For example, how will your organization measure the department’s performance? Create the department’s scorecard before hiring staff or outsourced professionals to be part of the function.

Tip: Start with the end in mind. What does a successful internal audit function “look” like? The end state will include both quantitative and qualitative goals that, once documented, will serve as the roadmap to create the function.

2.      How much will the new department cost to staff and maintain? Ensuring the adequate funding exists is a critical step in the process. How many internal auditors will your company need to operate the department? What type of expertise will the staff need to be successful?

3.      Does outsourcing the internal audit function make sense? The proposed NASDAQ rule specifically states that a company can engage a third-party firm to provide internal audit related services. Before investing the time, effort, and expense associated with creating a department from scratch, contact your accounting firm to determine if it can run your internal audit function. Using a third-party service offers a number of benefits including:

  • Access to qualified accounting staff on demand, and
  • Exposure to the latest internal audit best practices.

If you decide to staff the audit function in-house, anticipate the future demand for internal auditors. The availability of qualified candidates may decrease considerably. Consider how your organization will locate candidates. Do you have an employee referral program in place? If not, does it make sense to start one? Has your organization previously identified executive recruiters with the relevant experience to help you locate internal auditors? Does it make sense to engage a retained recruitment consultant to locate the internal audit department’s senior management?

Whether your company decides to outsource or build the internal audit function internally, the creation of a new department is about more than just complying with the NASDAQ proposed rule. An effective internal audit function provides your company’s executives with a much stronger understanding of risk, which consequently results in more intelligent decision-making that can directly affect the bottom line.