Audit Committee Charter: Rule 10A-3, Independence, and Auditor Oversight

An audit committee charter for a U.S.-listed public company must meet the requirements of Sarbanes-Oxley Section 301, SEC Rule 10A-3, and the listing rules of the exchange the company trades on. Together those sources dictate the charter’s core content: the committee’s authority over the outside auditor, independence standards for members, procedures for handling accounting complaints, the committee’s power to hire and fund its own advisors, and — through exchange rules — annual self-review, financial expertise on the committee, and public posting of the document itself.¹

The Federal Floor: Sarbanes-Oxley and Rule 10A-3

Section 301 of the Sarbanes-Oxley Act, codified at 15 U.S.C. § 78j-1(m), directed the SEC to require every national securities exchange to prohibit the listing of any company whose audit committee fails to meet specified standards.¹ The SEC implemented that mandate through Rule 10A-3 under the Securities Exchange Act of 1934.² The SEC’s companion final rule confirmed that non-compliant companies face prohibition from listing.³

A charter that meets the federal floor must address five subjects:

The committee’s direct responsibility for the appointment, compensation, and oversight of the registered public accounting firm that audits the company.
Independence criteria that every member must satisfy.
Procedures for receiving, retaining, and handling complaints about accounting, internal controls, and auditing, plus a confidential, anonymous channel for employees.
The committee’s authority to engage independent counsel and other advisors as it determines necessary.
Company funding, at levels the committee determines, for the auditor, the advisors, and the committee’s ordinary administrative expenses.²

What the Exchanges Add

Both major U.S. exchanges require a formal written charter as a condition of listing, and both push beyond the federal minimum.

Nasdaq Rule 5605(c)(1) requires every listed company to certify that it has adopted a formal written charter and that the committee will review and reassess the charter’s adequacy on an annual basis. The document must set out the committee’s scope of responsibilities, its structure and membership requirements, its role in ensuring auditor independence, and its purpose of overseeing the accounting and financial reporting processes.⁴

Section 303A.07(b) of the NYSE Listed Company Manual requires the charter to cover the duties in Rule 10A-3 plus additional responsibilities: obtaining an annual report from the independent auditor on its internal quality-control procedures, reviewing annual and quarterly financial statements with management and the auditor, discussing earnings press releases and guidance, reviewing risk-management policies, holding separate meetings with management and the auditors, and reporting regularly to the full board.⁵

Authority Over the Outside Auditor

The single most consequential provision is who controls the auditor relationship. Under federal law, the audit committee, not management, is directly responsible for appointing, compensating, and overseeing the registered public accounting firm that audits the company. The outside auditors report to the committee.¹

To make oversight real, the law gives the committee power to hire independent legal counsel, accountants, and other outside advisors whenever it determines they are necessary, and requires the company to fund those engagements at whatever level the committee considers appropriate. Management cannot veto the spending.² A well-drafted charter also addresses committee review of related-party transactions and sets policies on hiring employees or former employees of the audit firm.

Complaint and Whistleblower Procedures

The charter must establish two distinct intake mechanisms. The first is a procedure for receiving, retaining, and investigating complaints the company receives about accounting, internal controls, or auditing matters, from any source. The second is a channel that lets employees submit concerns about questionable accounting or auditing on a confidential, anonymous basis.² The rule does not prescribe a particular format; ethics hotlines run by third-party providers are the common implementation.

Independence and Member Qualifications

Federal independence is a bright line. An audit committee member cannot accept any consulting, advisory, or other compensatory fee from the company or its subsidiaries, directly or indirectly, beyond board and committee compensation, and cannot be an affiliated person of the company or any subsidiary. Fixed retirement plan payments for prior service are permitted if they are not contingent on continued service.²

Exchange rules layer on qualification requirements. Nasdaq requires a minimum of three members, all of whom must be able to read and understand fundamental financial statements — a balance sheet, income statement, and cash flow statement. At least one member must have past employment experience in finance or accounting, a professional accounting certification, or comparable experience such as service as a CEO, CFO, or other senior officer with financial oversight responsibilities.⁴

The Audit Committee Financial Expert

Separately, SEC Regulation S-K requires each company to disclose in its annual report whether the board has determined that at least one member of the audit committee qualifies as an audit committee financial expert, and if not, why. The SEC defines the expert as a person with all five of the following attributes:

An understanding of generally accepted accounting principles and financial statements.
The ability to assess the general application of those principles in connection with the accounting for estimates, accruals, and reserves.
Experience preparing, auditing, analyzing, or evaluating financial statements of comparable breadth and complexity to those of the company, or experience actively supervising someone doing that work.
An understanding of internal controls over financial reporting.
An understanding of audit committee functions.

Those attributes must have been acquired through hands-on experience: as a principal financial officer, controller, public accountant, or auditor, or in supervising such persons, or in overseeing companies or accountants in the preparation, auditing, or evaluation of financial statements.⁶

A safe harbor protects the designee. Being identified as the audit committee financial expert does not make that person an expert for any purpose, including for Section 11 liability, and does not impose duties or liability greater than those of other committee members.⁶

Adoption, Annual Review, and Public Posting

The full board must formally approve the charter before it takes effect, and the minutes should reflect approval of the specific duties and authorities granted. Both NYSE and Nasdaq require the committee to review and reassess the charter’s adequacy at least once a year, with any amendments returning to the board for approval.⁴

Once adopted, the charter must be made available on or through the company’s website.⁷ SEC rules add proxy-statement disclosure: the company must state whether the board has adopted a written charter and must include a copy of the charter as an appendix to the proxy statement at least once every three fiscal years, with the Form 10-K available as an alternative vehicle for companies that do not file a separate proxy.⁸

Consequences If the Committee Falls Out of Compliance

Federal law contemplates cure periods before delisting. Under 15 U.S.C. § 78j-1(m)(1)(B), the SEC’s rules must give a company an opportunity to fix defects before its securities are actually prohibited from listing.¹

Nasdaq has spelled out those grace windows. If a member loses independence for reasons outside the member’s reasonable control, that member may remain on the committee until the earlier of the next annual shareholders’ meeting or one year from the triggering event. If a vacancy drops the committee below three members, the company has the same window to fill the seat. The company must notify Nasdaq immediately on learning of the non-compliance.⁴

If the defect is not cured, the exchange can move to delist. Committee members who fail to carry out the duties in the charter can face breach-of-fiduciary-duty claims from shareholders. The authority to retain independent advisors at company expense exists in part as a defense: members who conduct appropriate diligence and rely in good faith on competent counsel are better positioned against personal liability.

Private Companies and Nonprofits

These federal and exchange requirements apply to publicly listed companies. Private companies and nonprofits are not bound by Sarbanes-Oxley’s audit committee provisions or exchange listing rules, though many adopt charters voluntarily. For tax-exempt organizations, Form 990 (Part XII, Line 2c) asks whether the organization has a committee that assumes responsibility for oversight of the audit and selection of the independent accountant; a “no” answer is legal but publicly visible.⁹

1
GovInfo. 15 USC 78j-1 – Audit Requirements
2
eCFR. 17 CFR 240.10A-3 – Listing Standards Relating to Audit Committees
3
U.S. Securities and Exchange Commission. Standards Relating to Listed Company Audit Committees
4
The Nasdaq Stock Market. Nasdaq 5600 Series – Corporate Governance Requirements
5
NYSE. NYSE Corporate Governance Rules – Section 303A.07
6
eCFR. 17 CFR 229.407 – Corporate Governance
7
NYSE. NYSE Listed Company Manual Section 303A FAQ
8
U.S. Securities and Exchange Commission. Audit Committee Disclosure
9
Internal Revenue Service. Instructions for Form 990