IIA Winnipeg Ethics · Entities (SPEs) Partnership or other vehicle designed to offload Enron debt...

© 2002, 2003 PDK Control Consulting International Ltd 1

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Ethics in 2003

IIA WinnipegAnnual Wind-up Dinner

27 May 2003

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a new world for auditors and directors

PDK Control ConsultingInternational Ltd.

Paul MakoszChair IIA International Ethics CommitteeChief Executive Officer, PDK

PDK 2

topicsSystemic breakdown & root causesReactionThe New World post Sarbanes OxleyEthics and the role of internal auditImmunizing your organization

PDK 3

Systemic breakdown& root causes


PDK 4

Enron root causes1 Ethics2 Ambition3 Complexity

WSJ - Feb 15/02

PDK 5

The CollaboratorsAccountantsBankersStockbroker AnalystsLawyersGovernmentDirectorsOther “bright sparks”

PDK 6

The ethics of Special PurposeEntities (SPEs)

Partnership or other vehicle designed to offloadEnron debt and increase revenueSell non-performing assets to the SPE at highvalue: reduce debt, increase cash flowGuarantee the SPE using Enron stock

“All they were doing was looking at GAAP and FASBdocuments and saying, “Well this is what it says,” and then finding the most byzantine way to get around the law so that it’s still legal but violating the spirit.” Financial Times, quoting former Enron employee


PDK 7

Ethics and concealment - Chewco and LJM1

Debt reductionsRevenue increasesFrom just 2 SPEsThere were over 3500SPEs by the endSPEs supported by Enronstock guarantees with pre-set “triggers”House of cards

-800

-600

-400

-200

0

200

400

1997

1998

1999

2000

Debt Revenue

PDK 8

Auditor conflict of interest52 million

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58

66

66

104

105

Source - Wall Street Journal and Proxy Filings

0% 20% 40% 60% 80% 100%

JP Morgan(PWC)

GE (KPMG)

Motorola(KPMG)

Sprint (E&Y)

Delphi (D&T)

AOL TW (E&Y)

Enron (AA)

Audit IT Consult

PDK 9

Missing the point - “F” gradeIf we risk being liable, become an LLPIf our own documents helped convict us, let’shave a policy to destroy documentsIf we lose our consulting business, double ourefforts to build new consulting clientsIf the SEC chair threatens us, lobby GovernmentHard to detect fraud? Disclaim liability for it.


PDK 10

Spreading the virus

Wall Street Journal

PDK 11

Why little investors have fled

ML tells the public “BUY” but internal memoscall stock “junk” or “crap”Big companies give analysts information threedays before public announcementsManagement making tens of millions inoptions - employees, small investors loseAuditors colluded or failed to detect grosslyfraudulent activity

PDK 12

Is this a systemic virus?

Enron

Arthur Andersen

WorldCom

Conseco

KMart

AOL Time Warner

Qwest

El PasoDynegy

Global Crossing

AONAdelphia

TycoJP Morgan Merrill Lynch

Ahold

Credit Suisse FB

XeroxHomestore

Citigroup

KPMG

Williams CompaniesSalomon

HealthcareSouth


PDK 13

Reaction

PDK 14

A clear and present danger"The sheer number and magnitude ofbreakdowns that have increasingly becomethe daily fare of the business press pose aclear and present danger to the effectivenessand efficiency of capital markets in which theUnited States has taken so much pride.

Paul VolckerMay 18, 2002 (NYT)

PDK 15

Revenge

“Jail ‘em if they’re guilty. All the Enron and Arthur Andersen principals and then some. Why? To save our system of corporate governance, which used to be the best in the world. To save investor confidence. Maybe even to save our entire free-market system of capitalism.”

Kudlow, Washington Times, February 2002


PDK 16

The crime statisticsImproper Revenue Recognition 126Improper Expense Recognition 101Improper accounting inconnection with business combinations 23Other accounting and reporting issues: 130

MD&A, related party transactions,non-monetary and roundtrip transactions,off-balance sheet, and non GAAP measures

PDK 17

The culpritsThe majority of persons held responsible forthe accounting violations were members ofissuer senior management.157 of the 227 matters involved chargesagainst at least 1 senior manager:

75 Chairmen of the Board, 111 CEOs, 111Presidents, 105 CFOs, 21 COOs, 16 CAOs, and27 VPs

PDK 18

WSJ - Apr 29/03


PDK 19

Sarbanes-OxleyOfficers sign-off onfinancials and controlsAudit committeesindependent,financially literateExternal auditors loseconsulting to auditclients

No misleading theauditors or omittingsignificant factsAnalysts reviewedInsiders regulatedPCAOB10 to 25 years jailWhistleblowersprotected

PDK 20

New RegulationCanada

Saucier Report (November 2001)Corporate Public Accountability BoardCICA (www.cica.ca)

Accounting Standards Board (SPE and G’tee)Public Interest and Integrity Committee (ED)

May 2003 “closer to Sarbanes-Oxley”

PDK 21

The new worldGovernance


PDK 22

Governance

ManagementDirectors

PDK 23

External pressures

DirectorsManagement

Stakeholders

Employees

PDK 24

Leadership collapse

Directors

Management

Stakeholders

Employees


PDK 25

IIA on GovernanceThe internal auditing activity shouldcontribute to the organization’s governanceprocess by evaluating and improving theprocess through which:

values and goals are established, sharedaccomplishment of goals is monitoredaccountability is ensuredvalues are preserved

IIA Standard 2130

PDK 26

The new worldAudit Committees

PDK 27

AC ExposuresIgnoranceIncompetenceLack of common senseFailure to complyManipulationManagement deception


PDK 28

AC FearsHow does this committee function?Do I understand this business?Who, what can I trust?Will I have the time I need to prepare?How can I see into this organization?Embarrassment, loss of reputationLiability

PDK 29

Common sense requirementsBusiness experience, competenceIntuitive understanding of peopleHealthy skepticism, independenceFinancial literacyWindow into the organizationTimeBudget

PDK 30

SOX challenges for the ACUnderstand full scope of internal controlFinancial literacyScrupulous disclosureExternal auditor fees and consultingComplaints, whistleblowing channelsInternal audit capacity, closenessJail and/or $ multi-million fines


PDK 31

Internal Auditors, ControllersAnticipate their needs for information andoffer trainingGive them time to absorb key informationTry to resolve differences with managementbefore going to themKeep reports frank, concise and graphic

PDK 32

PDK advice to the ACFinancial literacy is not nearly enoughUnderstand COSO, especially informalcontrol, thoroughly. Develop questions.Ask external and internal auditors how theywill get the answers you needInsist on efficiency and effectivenessTake a hard line on conflict of interestMake your internal audit window bigger

PDK 33

The new worldExternal Audit


PDK 34

Changes in External AuditSOX complianceForensic componentCOSO is big - moredependency onInternal AuditFees up 50 -100%Classify consulting asaudit (not good)

Demand efficiencyand effectivenessMeasure itInformal Control isbigger thanComplianceReject low value IADassistance

PDK 35

The new worldInternal Audit

PDK 36

Changes in Internal AuditScope of ControlIA mandateReportingRelationshipTimeframes - need forcontinuous monitoringMust prioritize on highvalue - E&E

TrainingCOSOSelf AssessmentEthics

Outside expert review(not your auditor)Open channels toBoard, CEO


PDK 37

Last wordsCreate and maintain open channels to theAC - on a personal as well as a formal basisThey are the last line of defence

DirectorsManagement

Stakeholders

Employees

PDK 38

Your role

PDK 39

Your roleEveryone else in thegame has beentagged and is “out”So …………….

You’re IT


PDK 40

IIA on the Auditor’s Role inEthics

Governance & Organizational CultureShared Responsibility for the OrganizationInternal Auditing as Ethics AdvocateAssessment of the Organization’s EthicalClimate

IIA Practice Advisory 2130

PDK 41

Potential

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Accident Tips Audit

Only 20% of frauds arerevealed by auditsYet ordinary people seethings every day - rightfrom the start - and theydon’t like what they seeThe 80% is anopportunity to preempt

PDK 42

Focus on peopleand ethics


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What we can doFocus on peopleBuild an auto-immune system

Facilitate Ethics Self AssessmentEncourage discussion of ethical dilemmas

Help the Audit CommitteeProvide a window into the organizationUpgrade your skills

PDK 44

Control Frameworks

Control Environment

Risk Assessment

Control Activities

Monitor

Info

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Comm

unication

Action

PURPOSEknowing what to do



COMMITMENTwanting to do it

CAPABILITYbeing able to do it

LEARNINGto do it better

COSO/Cadbury

CoCo

Ethics

Ethics

PDK 45

Talk to employees

Wall Street Journal/ Forbes


PDK 46

Listen to your peoplePeople need open communication to helpdeal with ethical dilemmasFor this they must feel free to talk aboutconcerns without fear of reprisalManagement needs to create a supportiveenvironment for this communication to occur

Guidance on Control, Criteria of Control Board, CICA

PDK 47

Ethics and CommunitiesEthics are principles of behavior regarded asdesirable by the majority of the population in acommunityEthics are not fixed. Theyvary by:

locationtimereligioncommunity Mexico Belmopan

GuatemalaSan Salvador

TegucigalpaManagua

San José

Panama

Havana

KingstonPort-au-Prince

Santo DomingoSan Juan

PDK 48

Personal ethics vary

Food, Shelter

Physical Safety

Association

SelfEsteem

SA

Risk

Oppo

rtuni

tyCDORNITVREORLS

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Solo

Community

Maslow’s Hierarchy of Needs


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Normal people/organizations

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PDK 50

Change is gradual

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PDK 51

High road or low road?

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PDK 52

A robust; B at risk; C too late

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PDK 53

Building an auto-immune system

PDK 54

How vaccination worksInject a serum similar to the real virusThe body’s immune system sees the intruderand develops antibodiesNote you just made one small injection - theantibodies replicated themselves.For 95% of individuals the antibodies willsuccessfully smother the real virus


PDK 55

Some signs of healthy ethicsLeaders talk ethics and walk the talkEmployees talk about ethicsIt’s OK to challenge new ideasFailures have repercussionsBreakdowns are discussed openlyGood examples are highlightedPersonal and corporate values align

PDK 56

Your immunization toolsControl frameworksESA workshops (diagnosis, vaccination)

vote on and discuss ethics indicatorsdiscuss dilemmas

Ethics surveysAdvocacy, leadership opportunitiesHot line

PDK 57

Run ethics self assessment -ESA

Facilitate workshopsDebate dilemmasSurvey staff andstakeholders on ethicsListen activelyDiscuss hot issueswith managementBe a leader


PDK 58

What to look forCode of Conduct Open Communication

ProgramsSupport strategies

Leaders walk the talk Follow up on issues raised

Effective reporting mechanismsLearning opportunities

Regular declaration Internal/external surveys

Positive personnel practicesRegular process reviews

Clear delegationHiring checks

PDK 59

Ethics Radial(based on ESAvoting responses)

PDK 60

On stage dilemmaYour team is surprised when your VP comesin one day and asks you all to move down tothe 12th floor for a couple of hours. Thespace is set up to look like traders’ desks.He asks you to pretend to be traders whilehe brings through some prospective clientshe’d like to impress.


PDK 61

You decide to:A - Cancel appointments for the 2 hoursB - Act as well as you canC - Ask your VP why you need to do thisD - RefuseE - Call the hot lineF - Think of something else

PDK 62

Building an Ethics programTop management must be engagedInvolve employees at all levelsProject team (not HR) prepare a draftEmployees invited to participatePublish comments, rationaleManagement commitment, sign-offBoard input, final sign-off

PDK 63

When you are immuneWhen individualpeople (cells or nuclei)become aware andinvolved,they spot the wrongvalue as it emerges,they neutralize it,and it fades away

IIA Winnipeg Ethics · Entities (SPEs) Partnership or other vehicle designed to offload Enron debt...

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