TO: ALL TENNESSEE STATE CHARTERED BANKS AND SAVINGS BANKS

SUBJECT: External Audit

DATE: June 26, 2002

This Bulletin Supersedes B-91-2, dated April 26, 1991

T.C.A. § 45-2-402 (c): The board of directors shall cause a review, at least once in each calendar year at intervals of not more than fifteen (15) months, of all the affairs of the state bank, including the character and value of investments, loans, the efficiency of operating procedures, and any other matters as the commissioner may prescribe, with such review discussed and recorded in the minutes. Compliance with the external auditing requirements of the federal regulatory agencies shall be deemed as compliance with this subsection. However, the commissioner may require, at the commissioner’s discretion, any state bank to obtain a financial statement audit or balance sheet audit should conditions warrant that action.

Accurate financial reporting is essential to a bank’s safety and soundness. An external audit of the financial statements benefits management in the establishment and analysis of accounting and operating policies, internal controls, internal auditing procedures, and management information systems necessary to ensure fair presentation of the financial statements. An independent audit can benefit the Board regarding the directors’ fiduciary responsibilities and provides a greater assurance that financial reports are free of material misstatement and provide adequate disclosures.

Recent large corporate failures, capital markets volatility, and economic conditions have, among other things, led to severe criticism of virtually all areas of the nation’s financial reporting and auditing systems, which are fundamental to maintaining public confidence in our banking institutions. The Department of Financial Institutions must proactively assess risks within the Tennessee state-chartered banking system to effectively protect public interest. Therefore, the Commissioner is directing that all Tennessee state-chartered banks obtain an annual audit of its financial statements by an independent certified public accountant (unless its financial statements are included in the audit of its holding company’s consolidated financial statements).

An audit by an independent public accountant should be performed for the next required reporting period. Those few banks that have other auditing procedures performed as of June 30 each year will have until June 30, 2003 to meet the expanded auditing requirement. Otherwise, the Bulletin should be considered effective immediately. The preferred time of the independent annual audit of the bank’s financial statements would be at the institution’s fiscal year-end. However, if this would be a significant hardship for the financial institution and/or the certified public accounting firm to accomplish, a full financial audit performed as of a quarter-end will be acceptable.

Within 45 days of receiving the external audit, each bank should provide the Department a copy of the independent external audit, including any management letters. Also, each bank should promptly notify the Department when any independent public accountant is initially engaged to perform external auditing work and when a change in, or termination of, its independent accountant occurs.

Any questions should be directed to Bank Divison - Chief Administrator Jim Douthit or Financial Analyst Joyce Simmons at (615) 741-6013.