Thousands of articles have been written about the failures of Enron, Tyco, WorldCom and others. Lessons from these debacles have caused some changes in the ways public corporations and their boards function, but most analyses focus on modifications driven by governmental regulations and professional policies. Very little has focused on what companies are doing voluntarily to change.
Here are the voluntary ways many firms are closing potential governance and financial gaps.
Internal financial controls.
Reviews are being conducted to assess how current financial procedures and control functions might be improved and tightened. More board interest is centered on potential regulatory, financial, and ethical concerns to make certain these issues are being carefully considered in the decision-making process.
Reporting processes are changing for internal auditors. Some auditors now report directly to the CEO and the board audit committee. Larger contracts are scrutinized by high-level managers and board members. Subsidiary financial controls are also scrutinized, and the results reviewed by the board. Compliance committees operate at unit levels. Summary unit compliance reports are submitted to the unit’s general manager and the corporate compliance committee. Included in the report is a representation letter signed by the unit’s general manager and CFO.
Special attention is paid to assure the board that there is proper accounting recognition as to what is a capital expenditure and what is current income.
Companies are reviewing procedures once considered routine to ensure that financial and accounting translate complete rigorously and ethically and to validate the information developed by business units has validity.
Internal and external financial communications.
More financial information is becoming available, especially to analysts during quarterly earnings conference calls. Disclosures in various SEC reports are being expanded.
The board and its audit committee are involved in earnings reporting systems. The audit committee chair may review earnings press releases before making them public. Board members now have access to external auditor’s financial documents to affirm the firm’s financial status. Some firms are stating in their 10-Qs that they do not have any off-balance sheet financing.
The trend is to expand the ongoing communication with the financial community between the quarterly reports. The increased disclosures from the operating units may portend a trend to communicating unit reporting more openly, like separate businesses.
Ethics codes and procedures for employee behavior.
Companies are reviewing their ethics codes and seeking ways to improve their visibility. One company is requiring all financial managers to sign a statement that they will abide by the Financial Executives Institute’s Code of Conduct. These statements are then reviewed the board audit committee. Another plans to ask all financial managers to sign an annual statement of compliance. To identify potential conflicts of interest, one firm may require all top executives to submit their personal tax returns for review by its outside legal firm.
Employee “hotlines” are being established, so that the compliance committee and management can review major complaints. If warranted, complaints are then forwarded to the board audit committee. Initial attention is given to improving policies where specific rules and regulations can be implemented.
External auditors and board audit committees.
Many firms no longer have a relationship with Arthur Andersen. The number of meetings of the board and its audit committee is increasing.
One company has its board and audit committee meeting in executive session with external auditors six times a year. Membership of audit committees is increasing to allow at least half of the members to have a financial or accounting background. As audit committees become more independent of management, more detailed disclosures will appear in proxy statements, in detailed financial transaction reviews, and in audit committee reports.
Boards are also defining, or restricting, the types of services that can be purchased from audit firms. Use of different firms for auditing and consulting services appears to be the major change. Companies are now require audit committee pre-approval for new services purchased from an external auditing firm.
Several companies had outsourced their internal audit function. These firms are now developing an internal department, reporting to the CFO, as well as having a reporting relationship with the board audit committee. Some have internal audit reporting directly to the CEO.
Companies are analyzing the “protective measures” being taken by external auditing firms to reduce the audit firm’s risk level. Quarterly meetings between the board audit committee and the external auditors are being held accountable to keep the audit committee more informed. In one firm, the audit committee will review quarterly results and question the external auditor, before the earnings statement is released to the public.
The relationships between client firms and auditors become unstable as auditing problems become public. As boards become more vigilant, look for more conflict-ridden based changes.
Board of directors.
Senior managers will meet more frequently with board members, either formally at board meetings or informally at other times. For its board members, one firm is offers weekly communications on progress.
Attention is being directed to Directors and Officers liability policies to assure directors that coverage is adequate. Audit committees are encouraged by their board colleagues to be more proactive and to provide more specific directives to management. This might be done annually or periodically through individual projects. Director education is becoming more popular, as firms want directors to become more comfortable with their responsibilities.
Increasingly active boards, along with more active committee chairs will become common. The big question is whether they will become sufficiently active to help avoid future failures.
Long-term Management Implications
While voluntary changes in procedures often take considerable time, the impact of several highly visible bankruptcies will create significant changes in how Corporate America does business. The examples of voluntary options being implemented or considered by CFOs are many. What remains to be seen is whether it will take legislative action or SEC directive to put teeth into the changes. Clearly, many of the items reported are self-protective, directed at keeping the company out of trouble with its stakeholders. How well those stakeholders will be protected may be determined by the initiatives developed by external forces. Political considerations, inertia, self-delusion and other factors may inhibit more meaningful changes being instituted voluntarily.
Reducing corruptive influences should be the goal of regulators managers and directors as they make voluntary changes.
Compare the voluntary actions your firm has taken against this list to assess whether your firm has some major governance gaps.