Audit committees bracing for shakeup. (Working with Boards).

Sun Microsystems' board of directors recently appointed two high-profile professionals to its audit committee. In the process, Sun could well be setting the gold standard for Corporate America.

On Sept. 30, the Santa Clara, Calif-based high technology company, best known for its computer workstations and its Java language, named Lynn Turner -- the former chief accountant at the Securities and Exchange Commission and a fierce critic of many current accounting practices -- to its board. At the same time, Sun appointed its former chief financial officer, Michael Lehman, to serve alongside Turner.

"It's a gutsy move," says Patrick McGurn, vice president and special counsel at Institutional Shareholder Services, a consulting firm in Rockville, Md., that advises large institutional investors on corporate governance issues. Citing in particular the appointment of Turner, who is now an accounting professor at Cob orado State University and director of the college's Center for Quality Financial Reporting, McGurn remarked: "Talk about getting an independent person on the audit committee!"

Even hardened skeptics like McGurn admit that they are witnessing instances of positive, if gradual, changes in corporate governance emerging in the months following the Enron debacle and a raft of other corporate accounting scandals -- scandals in which Corporate America's boards of directors often failed to provide effective leadership. Audit committee ineptitude, in particular, is generally acknowledged to be among the principal reasons why shareholders suffered billions of dollars in losses over the last year or so.

"Audit committees have not been the vigilant, active overseer they are supposed to be," says former University of Texas accounting professor Dan Guy, co-author of a book on audit committees and a frequent expert witness in complex financial litigation. "They haven't asked the right questions."

That realization has made audit committees an important focus of legislative, regulatory and institutional reforms. Spurred on by defrauded investors and an outraged public, the leading stock exchanges, the Securities and Exchange Commission and Congress are all insisting that audit committees exhibit higher standards of ethics, greater independence and competence.

Amidst the welter of reforms, audit committee members will now be required to be fully independent of a company and its management. That means that they cannot be on the company payroll, represent a customer or law firm with ties to the business, or be a family member or relative; their only form of compensation should be directors' fees. "The problem has been independence," asserts Charles Elson, a law professor and director of the Center of Corporate Governance at the University of Delaware. "1 think that has to be issue No. 1."

But the requirement that all audit committee members must possess financial literacy, and that at least one member of the audit committee must be a financial expert -- once "best practices" but now codified into law by the summer passage of the Sarbanes-Oxley Act -- is sending "shock waves" through the country's corporate boardrooms, asserts Thomas Schiro, deputy national managing partner for assurance and advisory services at Deloitte & Touche.

The new rules, which still must be refined and interpreted by the SEC, represent "a significant and specific hurdle" for many directors who already serve on audit committees, as well as for prospective members, Schiro adds.

These new rules are already spurring governing bodies of U.S. corporations to take inventory. Only 2 percent of U.S. companies in the S&P 500 could count a retired audit partner from an accounting firm on their boards, according to a review of 2002 proxy statements, reports Julie Daum, practice leader for U.S. board services at executive recruiter Spencer Stuart. No more than 3 percent could boast a current or former CFO. "At most, that's only 5 percent" of board members who qualify as financial experts. That's "a pretty big gap," she says.

While there is a paucity of hard data at this juncture -- numerous studies are in the works, including a major survey by KPMG's Audit Committee Institute -- it does appear that audit committees are in the midst of a cultural shift. What is emerging, say experts on audit committees and corporate governance, members of boards and audit committees themselves, and executives at search firms who recruit and place directors at major U.S. companies, is the likelihood that many current audit committee members could be shifting committee assignments. Spencer Stuart's Daum says many boards are simply expanding their audit committees to accommodate a financial expert, who is most likely to assume the duties as committee chair.

At the same time, many board members are resigning. This may be attributable as much to the fact that many companies are restricting the number of boards on which their own chief executive officers serve -- CEOs are still the most popular board candidates -- as to the more elevated standards required by law. Charles King, managing director and head of global board services at search firm Korn/Ferry International, reports that a decade ago the average CEO sat on four boards; today, that number has shrunk to 1.7.

As many as 35 percent of the country's board seats could be vacated in the coming year, reckons Kerry Moynihan, managing partner at executive search firm Christian and Timbers in Vienna, Va. At the same time, Moynihan notes, many otherwise dedicated and respected directors now serving on audit committees are reacting with self-doubt and trepidation to Sarbanes-Oxley.

Rosina Dixon agrees. She is a physician and a pharmaceutical industry consultant who serves on the governance committees of two corporate boards, Church & Dwight and Enzon Pharmaceuticals Inc. She reports that at one of the companies, the CFO has resigned, saying that he wasn't sure he could certify all of the company's income statements, as required by Sarbanes-Oxley. The new law is also having a profound effect on the complexion of the boards at both companies, she adds. "We're looking around and, from the way the law is written -- it's incredibly strict -- we're not sure if anyone on the audit committee qualifies as an expert."

Moynihan reports that such concerns are by no means isolated. He cites one director who is currently serving with distinction on audit committees at four large companies but who is contemplating tendering his resignation to each. "This is a man who told me, 'Under the new rules, I'm not sure I'm qualified,"' Moynihan says. "I thought this was interesting because he had been doing his job well at companies that were cited for good governance."

If people like him opt off the audit committee, "CFOs and many retired audit partners are going to be called to the table as, quote, 'financial experts,"' says Moynihan, who would rather see audit committee vacancies filled with current or former CFOs rather than with retired audit partners.

While a broad-gauged, big-picture-thinking CFO or retired CFO -- a person whom McGum calls the "mm-me of the CEO" -- might be the one who fits most comfortably into the status quo, some argue otherwise. Donald Keough, chairman of Allen & Co. and former chairman of The Coca-Cola Co., has argued that a "green-eye-shade" CFO, rather than the flashier CFO cut in the cloth of Enron's Andrew Fastow or WorldCom's Scott Sullivan, might be the kind of person best suited to assume those duties. Says McGurn: "The CFOs who would be the new role model for an accounting board member are probably the people you don't see. They're the ones you'll never hear about because they are working away at their jobs in relative obscurity"

Janet Haugen, the CFO at Unisys Corp. who was recently named to the audit committee at SunGard Data Systems, says she felt the directorship of a software company in the nearby Philadelphia area made for a good fit. The support of Unisys's CEO and board sealed the deal. "I'm finding that the CFO is a great addition to a board," says Haugen, an FET member. "I wanted to bring industry experience that matched the opportunity. The real key is to have people with diversity of experience and in this time and environment."

Indeed, compliance with the law might require something of a cultural shift. Though some board experts disagree that a clubby atmosphere still prevails, in certain companies board seats are still occupied by "friends of the CEO" and celebrities. David Quinn, CFO at Bowles Fluidics Corp., is 65 years old and would like to serve on corporate boards when he retires, probably in a year or two. Quinn believes that connections play the key role in winning a directorship. "I have friends who serve on boards in Florida and Canada, and that's what they tell me," he says. "There's no logic to it."

Nell Minow, director of the Corporate Library and a veteran corporate governance activist, notes that, prior to his murder trial, O.J. Simpson sat on the audit committee of Infinity Broadcasting. She also notes that former basketball great Julius Erving serves on the board of Saks Inc., where he has missed more than 25 percent of audit committee meetings, according to proxy statements.

In addition to displaying greater financial acumen, new members on audit committees must be willing to attend more frequent, and longer, meetings. Korn/Ferry's King reports that the average board member spends 189 hours a year on board duties, almost double the 100 hours of a decade ago.

And, the workload is more detailed, demanding and increasingly more somber. For example, audit committee members are required to review whistleblowers' complaints, in addition to setting the external auditor's fees and reviewing the scope of the firm's services. Meanwhile, as currently constituted, the external auditor clearly serves the interests of the audit committee and not those of management -- something that may not have fully registered yet with many audit committee members.

Minow gives an example of an otherwise hard-charging corporate leader who admitted to being somewhat passive in his capacity as an audit committee member. "One CEO told me at a conference last year, 'I'm on the audit committee of another board, and the auditors never give me the figures in a format that I can understand," she says. "I had to tell him that the auditors are forgetting who they work for -- they work for the audit committee. They have to give you the numbers any way you want them. I don't care if it's on pink paper."

Recruiters say that they are seeing an unprecedented upswing in demand for not just for board members, but for audit committee service -- even specific requests of audit committee chairmen. King says he is currently handling 10 search assignments for a financial expert; as recently as a year ago, he might have one such request underway at any time.

Corporate governance expert Elson, who serves on the audit committees at Sunbeam Corp., Alderwoods Group and Autozone, says that at one of his companies, "a director who served on the audit committee resigned, and it's not as easy as it once was to find a replacement."

Elson, who insists that financial expertise is "no silver bullet" answer to financial skullduggery, has nonetheless founded a "directors college" at the University of Delaware where directors can improve their financial literacy. The first such tutorial, featuring accounting experts from co-sponsor PricewaterhouseCoopers, was held Nov. 8 and drew about 50 directors, including board members from Atran, Burlington Resources, Corning Inc. and Gateway Inc.

For self-confident and experienced board members with a track record of service on audit committees, meanwhile, these could be the best of times. And if that person can bring a bit of diversity to a board, so much the better. Just ask Diane Harris, president of Hypotenuse, a mergers and acquisitions firm in upstate New York and an audit committee member at FlowServe, a Dallas-based manufacturer of pumps and valves for the chemical and nuclear power industries.

"I've had a lot of calls from executive search firms lately," she says, and at least three have told her that she is actively being considered as a candidate. "All of them specifically target the board of directors' audit committee," she adds. "From the phone calls I'm getting, I can tell that these companies are all making major changes."

Paul Sweeney is a freelance business writer in Brooklyn, N.Y., and a frequent contributor to Financial Executive. He can be reached at 718.636.2036.