Internal controls are often considered a necessary evil by finance executives and board members. And it's true that with so many strategic issues to address, it can be challenging to carve out the time and attention to ensure that internal controls are in place, designed appropriately, and operating effectively.
Be we need only review some recent financial news headlines to remind us of the critical role that internal controls in particular and financial integrity in general play in a company. What happens when internal controls are absent, ignored, or just stop working? Read on.
UBS: "Rogue" Trader Hit Firm - A 31-year-old trader made unauthorized trading bets that resulted in $2 billion in losses for UBS AG. Moody's Investors Service believes that the loss would be financially "manageable" for UBS. But investors weren't so confident, sending UBS shares falling 11% the day the news broke. This incident suggests UBS needs to reevaluate its internal controls over trading as well as its entity-level controls, which define corporate culture and "tone-at-the-top." For more insight check out a blog post by Robert Green, CPA, in Forbes.
Bank of America Told to Pay Whistleblower $930,000 - The bad news continues for Bank of America, which earlier this week was found guilty of violating federal whistleblower protections and ordered to pay $930,000 to a former employee. Sure $930,000 in itself isn't material for a megabank like Bank of America. But the case reflects the trouble BofA has faced since it acquired Countrywide Financial in 2008. The employee involved in this case worked at Countrywide investigating improper loan processes but was fired by BofA shortly after the acquisition. Given the outrage over Countrywide's practices, and the role the company played in the mortgage meltdown, you'd think BofA would have been smart enough not to fire the person trying to root out improprieties -- even if she had an abrasive personality (as BofA claimed but her coworkers denied). Incidentally, $930K pales in comparison to what BofA paid (more than $67.5 million) to get Countrywide's former executives off the hook with the SEC. What does that say about "tone-at-the-top"? Here I see weakness in in governance and entity-level controls that relate to whistleblower processes and company culture.
Norway Opens Door to US Audit Watchdog - The past year has seen a number of financial reporting scandals amongst US-listed Chinese companies. But the SEC has been thwarted in its efforts to investigate the scandals - and the audit firms involved in them - by regulators in China. As it turns out, China is not the only country that prohibits inspections of firms listed on US exchanges but based elsewhere. The UK, Norway, and other European countries have taken the attitude, "just trust us," and kept US regulatory agencies and auditing boards out. Until now. Citing the need for joint cooperation in these "challenging economic times," James Doty, president of the PCAOB announced an agreement with audit regulators in Norway, and progress with audit regulators in other countries. The PCAOB will try to hammer out an agreement with China later this fall -- which may not be fast enough for at least one Big Four audit firm whose work in China is under investigation by the SEC.
The Biggest IPO You Haven't Heard Of - The tension between Chinese audit regulators and the SEC/PCAOB does not seem to be stopping Chinese online retailer Jingdong Century Trading Co.'s bid for a billion dollar IPO on a US exchange. IPO bankers are vying for the work, and I suspect the Big Four audit firms are competing for SOX and audit-related engagements. An IPO requires more scruity than the "back-door" reverse merger route to going public that other Chinesec companies have taken. Still, given the accounting scandals that have rocked Chinese companies listed on US exchanges, it's easy to see why some investors would be nervous. In all the hype, I doubt anyone will be focusing on Jingdong's internal controls over financial reporting. But internal controls are exactly what long-term investors should be concerned about -- not just at Jingdong but at any company on which they are betting.