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What's New
CFOs face auditor crackdown on internal controls
CFOs should partner with supply-chain executives Editor's Corner: Enron redux Also Noted: News scan: Auditor signatures; JPM settlement; and much more... News From the Fierce Network:
1. The mother of all private equity buyouts?
2. Yale frowns on private equity
3. NYSE holds successful Twitter test
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Enron redux
Macro concerns have given way to micro ones for CFOs, as audit season approaches. Just in time, the PCAOB warned late last week that deficiencies in companies' internal controls were on the rise. And our first story today by Hilary Johnson lays out the problems in detail. But the rise in deficiencies doesn't surprise is, as it's in line with the backlash against regulation we're seeing in such legislative efforts as the JOBS Act, which, however well intended, will in our view inevitably lead to serious corporate accounting problems. Still, it's startling that companies, regulators and investors alike seem to have forgotten the reason Sarbanes-Oxley exists in the first place. (Enron, anyone?) Indeed, a conference that took place last week around the same time that the PCAOB issued its alert heard experts say that good controls can help a company perform well.
The thing is, we've heard that observation made time and again by CFOs of major companies. "There are real benefits to Sarbanes-Oxley," John Connors, the former CFO of Microsoft, told the McKinsey Quarterly way back in 2005. Connors explained that Microsoft previously understood what its key controls and materiality threshold were and had tight budgeting, close processes and strong internal and external audits. But he said that the software giant didn't document everything in the way that the Sarbanes-Oxley legislation required. So the company undertook what Connors described as "a complete business-process map of every transaction flow that affects the financials." In so doing, he noted, Microsoft improved its revenue and procurement processes, helping management "run the company in a more disciplined way." In other words, Connors explained, "we have gotten real business value out of all that process documentation." So why don't all companies embrace such an approach? Beats us. After all, they're spending tons of money on information systems that are supposed to help them run the business better. Isn't SarbOx just a means of tying that information to financial results? Oh, sure, we've heard the common refrain that compliance costs are too steep, or that the work involved is simply a time suck. But that's a lame excuse, as a rise in financial fraud that reflects business failure will ultimately show. And for this, CFOs will have been paid good money. - Ron Read more about: Enron, Microsoft
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Today's Top News CFOs face auditor crackdown on internal controls
For CFOs, the takeaway from last week's PCAOB Staff Audit Practice Alert on internal control over financial reporting is that audit season won't be getting any less stressful any time soon. For the second time in less than a year, the Public Company Accounting Oversight Board advised auditors, and indeed audit committees, to be vigilant about internal controls. "Auditors should take note of the matters discussed in this alert in planning and performing their audits, given the importance of the controls companies use to produce their financial statements," PCAOB Chairman James R. Doty said in the accompanying press release to Staff Audit Practice Alert No. 11, "Considerations for Audits of Internal Control Over Financial Reporting," released Thursday. The guidance comes after the PCAOB observed "significant number of audit deficiencies" over the past three years, the release noted. Audit firms will likely be sharpening their game, said James DeLoach, Jr., a managing director at Protiviti, Inc., in a phone interview. "As a CFO, I should not be surprised if my auditor comes to me and says 'We need to expand our scope. There are certain things we need to do.' "And I may not like the demands it puts on my people, and the cost of the audit. But it's the reality. It's a tough environment for the audit firms." Some of the areas where the PCAOB urged greater attention include: selecting controls to test; testing management review controls; information technology considerations, including system-generated data and reports; and using the work of others. All of the areas have been highlighted before, and in fact reemphasize the principle established under PCAOB's Auditing Standard No. 5, "An Audit of Internal Control Over Financial Reporting That is Integrated with an Audit of Financial Statements" -- that is, a top down, risk-based approach that avoids unnecessary procedures and keeps the audit focused on material concerns. In fact, it's in that principle that CFOs have room, and even a mandate, to set and guide the audit agenda, Mr. DeLoach said. CFOs can help keep audit teams, and indeed audit committees, supplied with the most important information to help them keep Audit Standard No. 5 top of mind.. "The CFO is certainly justified in inquiring about where additional work is being applied" and how it supports Auditing Standard No. 5, Mr. DeLoach said. "That is a dynamic that the CFO can bring to the table." Thursday's release of Audit Practice Alert No. 11 comes after a December 2012 report on 2010 inspections of audits of internal control over financial reporting at audit firms. The report stated that 15 percent of 309 audit engagements failed to properly show effectiveness of internal controls. "Inspections in subsequent years have continued to identify similarly high levels of deficiencies," Thursday's release noted. For more:
- read the PCAOB alert
- read this WSJ blog post Read more about: audit, Protiviti
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CFOs should partner with supply-chain executives
CFOs have an important role to play in supply-chain management, according to an Ernst & Young survey that shows companies where CFOs and supply-chain leaders work closely together perform better financially. That it pays off when finance partners work with the supply chain doesn't seem surprising given the importance of input costs and working capital management to a company's results. Just last month, snack-food manufacturer Mondelez announced plans to realize $3 billion in savings over the next three years with supply-chain efforts that include investing in new manufacturing lines and new factories and better managing its working capital. Over the last decade, U.S. companies have devoted much effort to fine-tuning their working capital management, although improvement on that front seems to have stalled. The E&Y report notes the expertise CFOs can bring in the areas of strategy and deal-making as companies augment their supply chains via acquisitions. Just last week, Samsung announced it was taking a stake in Corning, a move that guarantees it access to a type of glass made by Corning that's used in many mobile devices. E&Y's survey of 423 CFOs and heads of supply-chain groups worldwide found that just 26 percent of finance executives and 21 percent of supply chain executives describe the relationship between the two positions at their company as a close collaboration. But 48 percent of companies where that's the case saw their EBITDA growth increase by more than 5 percent in the past year, versus just 22 percent of other companies. The survey results suggest, though, that many are moving toward working in closer partnership. Seventy percent of CFOs surveyed said the relationship between finance and supply chain has become more collaborative over the past three years, as did 63 percent of the supply chain executives. CFOs saw rising external costs as the main factor driving collaboration (30 percent), followed by the pace of change (27 percent). Supply chain executives cited the globalization of the supply chain (38 percent) and the pace of change (34 percent). Of course, collaboration takes time. CFOs who collaborate spend 25 percent of their time with the supply-chain leader, while other CFOs spend 12 percent of their time with the supply-chain executive. And even that greater amount of time may not be enough: CFOs who collaborate say they should be spending a third of their time on supply chain; traditional CFOs think they should be spending 20 percent of their time on these issues. According to the survey, CFOs and supply-chain executives who work closely together are most likely to have held their positions for less than five years and to work at a technology company with revenue of more than $1 billion. Such collaboration is most common in the U.S., South Korea, and Singapore, the survey found, and least common in Western Europe. For more:
- see the Ernst & Young report
- see this SupplyManagement.com story
- see this Hackett Group report Read more about: Supply Chain
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Also Noted >> Compliance: Big 4 opposes the PCAOB's efforts to get more transparent audits The PCAOB is said to be pushing back against accounting industry opposition to having individual partners sign their names on financial audits. The regulatory body's chief, James Doty, wants to push ahead with plans for the requirement even though the Big Four say there's no benefit to having auditors be personally responsible for their work. Yes, it might not prevent such abuses such as that seen last year in the case of Scott London, which I wrote about for Corporate Secretary. But the firms evidently haven't seen a new study that shows that companies would benefit from such a requirement because it boosts investor confidence, which translates into a lower cost of capital. The industry's stance here reminds us of complaints against financial regulation of all kinds, especially the Sarbanes-Oxley and Dodd-Frank acts, in which only the costs of compliance are cited. Yet how often have we heard that investors reward U.S. companies and markets for their greater transparency? Apparently the industry most clearly charged with creating and maintaining such transparency doesn't much believe in its value. That makes one wonders whether the purported advantage can persist for long, or even whether it exists any longer. After all, it has directly led to anti-regulatory efforts such as the JOBS Act, which make markets less transparent. Read more >> Compliance: The JPM settlement shows again why big banks need to be run as utilities Francesco Guerrera of the WSJ explains why the government might be shooting itself in the foot by demanding that JPM relinquish its claim that it can put its WaMu legal liabilities to the FDIC, reducing the cost of its $13 billion settlement with the Department of Justice by about $4 billion. In addition, the bank may be able to recoup a sizable chunk of the rest as an IRS deduction. This reminds us that banks' losses, which are backstopped by taxpayers, are counted for book accounting purposes as assets, and once were considered regulatory capital to at least some degree by federal regulators. In other words, we can't punish banks for wrongdoing without punishing ourselves. But the Hobson's choices arising from attempts to holding too-big-to-fail banks' accountable for fraud and the like stem from a fundamental conflict of interest: Such banks at heart perform the service of public utilities, but their current ownership status denies that reality. That is, they're backed by taxpayer money but run not for the benefit of taxpayers but shareholders. And no amount of regulation can change the moral hazard that denying that fact creates. Yet such denial explains why five years after the financial crisis, and who knows how many words spent debating the ins and outs of the Dodd-Frank Act, we still have the same basic financial system in place that blew up the economy. Read more here and here In the captured regulators' department, the former secretary general of the Basel Committee says the Fed's proposal to require banks to maintain a minimum level of liquidity would likely boost the price of credit. Right on cue, we find that banks are padding profits by tapping reserves. >> Management: Whither China? Lots of news coming out of the world's No. 1 emerging market, and it's the usual confusingly mixed bag for multinationals wanting to tap opportunities there. The good news: China has taken another step forward toward a market economy, with the adoption of its equivalent of the U.S. prime rate, based on input from nine commercial banks. But tussles remain within China's Communist Party about the extent of such reforms. Then there's the country's slowing growth, though investors seem to think it's rebounding, at least in the short term. And while many observers think the government can manage whatever bubble materializes, simply because of its control over the banks, others contend that may not be as simple a proposition as the optimists think, if only because the government's legitimacy rests on an increasingly fragile base. (Nothing yet on whether this crash was just an accident.) Read more here, here and here >> Capital: Buybacks still in vogue Carl Icahn's latest push to get Apple to undertake $150 billion in buybacks, which would come on top of the $60-billion buyback program the company has already announced, may not be as necessary as he claims. CNBC predicts buybacks will pick up now that Fed tapering has been postponed as low rates help companies to finance stock purchases, and notes that companies announced $68.1 billion of buybacks in September. The thinking is that companies have used cheap financing courtesy of the Fed as a means to underwrite those buybacks. Nonfinancial companies have a post-crisis-high debt of $13.1 trillion on their balance sheets, compared to $1.8 trillion of cash that they've been hanging onto. And the postponement of tapering means companies are likely to take on more for the purpose of returning capital to investors. Read more >> Capital: Back to subprime, commercial version? Banks haven't been getting a Moody's rating on the riskier tranches of bond issues backed by commercial mortgages, Bloomberg points out. That's a sign that the credit quality of such deals is deteriorating. The lower tranche went rating-less in 9 of the 14 commercial-mortgage bond transactions Moody's rated since mid-July, according to Jefferies Group. This week, Deutsche Bank, Cantor Fitzgerald and UBS are selling a $1 billion transaction that doesn't carry a Moody's designation for a $64.3 million portion that Fitch Ratings and Kroll Bond Rating Agency ranked the lowest level of investment grade. Read more >> Capital: The U.S. has become a less attractive destination for direct investment U.S. multinationals aren't alone in finding better investment opportunities abroad. Foreign direct investment is down sharply, prompting President Barack Obama to engage in a White House road show. The U.S. attracted 37 percent of worldwide inward stock of foreign investment in 2000, but that share had fallen by more than half by last year, to 17 percent. The U.S. attracted $166 billion in foreign direct investment in 2012, a 28 percent decline compared with 2011 and slightly below 2010 levels. Read more Briefly noted: > Compliance with the Affordable Care Act may worry many companies, but health insurers are in a position to benefit. Or so investors believe. Article > The Fed and others have decided that a little more inflation would be a good thing, though lenders and fixed-income investors no doubt would disagree. (And it's about time, says Paul Krugman.) Article > Juniper Networks pays its software engineers more than any other tech company. Article > What's up at Procter & Gamble? CEO A. J. Lafley skipped the company's quarterly earnings call Friday. Article (Fortune) and article (WSJ) > A kind assessment of Twitter's valuation. Article > Blackstone's Tony James takes $88.6 million off the table. Article > SAP's CFO says company not interested in BlackBerry. Article > DuPont's CFO says chemical unit will name new management team next year. Article > Detroit isn't the only U.S. city struggling with its finances. Article And finally... Gone but not forgotten: Of the 250 largest companies in the S&P 500, J.C. Penney had the biggest gap between its CEO's pay and that of its average worker in 2012, according to Bloomberg. Sure enough, Ron Johnson is no longer the CEO. > Get Subscriptions to the Leading Finance Magazines for FREE Mercury Magazines offers top Finance titles for Free to professionals. No Credit Card Required. 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