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The recently enacted German Transparency and Disclosure Act has amended section 161 of the German Stock Corporation Act to provide, among other things, that German publicly listed companies must either comply with the German Corporate Governance Code (Deutscher Corporate Governance Kodex), as promulgated by the German Federal Ministry of Justice in November 2002, or explain why they will not be complying with the recommendations of the Code. As stated in its preamble, the purpose of the Code is both to restate existing statutory rules on the management and supervision of German publicly listed companies and to codify international and German best practices. It is intended to provide transparency and accountability to the German corporate governance system and foster the confidence of foreign and domestic investors as well as customers, employees and the general public in the management and supervision of German publicly listed companies.

Audit committees

One recommendation of the Code is that the supervisory board of a publicly listed company in Germany establish an audit committee (section 5.3.2 of the Code). It is interesting to note that, according to a survey of European companies conducted by KPMG before the Code's promulgation (Corporate Governance in Europe, KPMG Survey, 2001/2002), only 41% of the German respondents had established audit committees at that time. By comparison, almost all UK respondents reported the existence of such a committee.

The Code provides that the audit committee is responsible for overseeing matters relating to the following:

  • financial reporting;
  • risk management;
  • the independence of external auditors;
  • the retention of external auditors;
  • focal points of the audit; and
  • the external auditor's fee arrangement.

Financial reporting requirements

Matters of financial reporting are addressed in section 7.1 of the Code. This provision restates the general premises that the consolidated financial statements of a company should provide the main source of information for shareholders and other third parties and that these constituencies should be kept informed through interim reports. The Code does not say how often these reports should be issued. That will depend on the rules of the stock exchange and the segment in which the particular company is listed. Based on the new rules of the Frankfurt Stock Exchange, for instance, companies listed in the Prime Standard segment are subject to quarterly reporting requirements while those listed in the General Standard segment are only required to report semi-annually.

The Code makes a distinction between the accounting principles that should apply to consolidated financial statements and interim reports, on the one hand, and those that apply for tax purposes or for purposes of determining dividends and creditor protection, on the other. In the former case, financial reports are to be presented on the basis of internationally-accepted accounting principles, which also include US Gaap, while in the latter case, the annual statements should comply with the accounting standards and principles developed under the German Commercial Code (HGB).

While under the statutory rules of the German Stock Corporation Act a stock corporation can have up to five months to publish its annual report, the Code accelerates the deadlines for financial reports. It recommends that the annual consolidated statements of a publicly listed company be published within 90 days of the end of the company's fiscal year and that interim reports be published within 45 days of the end of the relevant fiscal period. The Code's 90-day rule for annual reports is even shorter than the requirements under the Frankfurt Stock Exchange Rules for Prime Standard companies, which allow four months for annual reports.

Risk management

Section 4.1.4 of the Code requires that the management board ensure that appropriate risk management and risk controls are put in place. This is a restatement of the statutory requirement in section 91 subsection 2 of the German Stock Corporations Act, which means that there is no availability to opt out of this requirement by publicly explaining a company's non-compliance. Each German stock corporation must have the appropriate risk management and risk controls in place. In addition, section 317 subsection 4 of the German Commercial Code requires the external auditors to review the measures taken by the company in this respect in the context of their annual audit of the company.

Thus, the only comply or explain flexibility provided under the Code is whether or not the company maintains an audit committee to supervise these matters. The Code does not elaborate on just how the audit committee is to proceed in monitoring a company's risk management and processes. Sound business sense will most likely dictate that the committee diligently assess the risks of the company, make an independent and informed decision on what the corresponding appropriate controls and measures should be and, finally, that the processes which are put in place on the basis of these assessments and actions are monitored in regular intervals and adapted to the changing risk profile of the company, if required. Because the external auditors will also report on their findings on this topic, the committee will ultimately also reflect and, if necessary, act on such findings.

The external auditor's independence

Section 7.2.1 subsection 1 of the Code recommends that, before making a proposal for the appointment of a particular external auditor, the audit committee obtain a detailed statement from the prospective auditor stating whether and, if applicable, which professional services, financial and other relationships exist between the auditor, the auditor's executive bodies and/or representatives and head auditors, on the one hand, and the company and members of its executive bodies, on the other hand, that could call such auditor's independence into question. This statement must also describe which other services, especially consulting services, were performed by the prospective auditor for the company in the past year as well as what services, if any, the auditor has been retained to provide in the future.

The audit mandate, focal points and fees

In part, section 5.3.2 of the Code, which deals with the retention of the external auditor, merely restates the statutory rule found in section 111, subsection 2, sentence 3 of the German Stock Corporation Act that a body other than the management board of the company, be it the supervisory board or the audit committee (if the company has one), retain the external auditor. However, the Code expands on this rule by requiring that the audit committee determine the focal points of the audit as well as review the fee arrangements with the auditor. In addition, section 7.2.1 subsection 2 of the Code recommends that the committee agree with the auditor that the committee chairman be informed immediately of any grounds for the auditor's disqualification or issues of impartiality (or, better said, lack thereof) which may arise in the course of the audit to the extent these cannot otherwise be resolved. Section 7.2.3 of the Code further provides that the committee arrange for the auditor to report promptly on all facts and events of relevance to the committee's tasks. And it continues by recommending that the audit committee ensure that the auditor reports any evidence of misstatements of the management board or the supervisory board under the Code.

Constitution of the audit committee

The Code is largely silent on how the audit committee should be constituted. It makes only two requirements (1) that the chairman of the committee not be a former management board member (section 5.3.2 of the Code) and (2) that the members of the committee have the requisite expertise (section 5.3.1, sentence 1 of the Code). For companies that are also subject to foreign audit committee rules, such as the SEC rules under the Sarbanes-Oxley Act, this could provide the necessary flexibility to come into compliance with both the foreign and the German rules. This will be even more the case in light of the SEC proposed exemptions for foreign issuers. In the case of issuers with two-tier boards, such as German companies, the SEC is proposing to allow the supervisory board to qualify as the board of directors under the proposed rule and either to form a separate audit committee of outside members or, if the entire supervisory board is independent within the meaning of the proposed rule, designate the entire supervisory board as the company's audit committee.


Generally, it can be expected that most large publicly listed companies will follow the Code's recommendations regarding audit committees. In the case of smaller companies, however, it may be more practical and appropriate for companies to opt out of the rule and to have the supervisory board take on the audit committee responsibilities, especially, as demonstrated by the proposed SEC exemptions, if the supervisory board is sufficiently independent.

Dr H Elizabeth Kroeger and Dr Peter Etzbach

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