Archives for posts with tag: Audit

The Wall Street Journal had an article recently about the former CEO of the “doomed brokerage firm” MF Global testifying that his firm relied on their auditors, Pricewaterhouse Coopers to “make sure its finances were accurate.”

The former CEO is Jon Corzine, who was the former Governor of New Jersey and before that the former head of that famed Wall Street firm, Goldman Sachs. Mr. Corzine agreed to pay a $5 million fine to settle his role in MF Global’s collapse. For a person whose net worth is estimated at around $300 million, this is not even a slap on the wrist.

A number of articles from Vanity Fair to the New York Times have been written about the collapse of MF Global, and the fact that neither Mr. Corzine or any other officers or directors were charged with a crime. It has been suggested, by others, that it may be due to the fact that Mr. Corzine was a major contributor to President Obama and the Democratic party. But I will not venture into politics, but rather just stay with business.

As an investment banker with Goldman Sachs, Mr. Corzine certainly understood what role auditors perform for all his many clients. The role of an outside auditor or CPA firm is to examine the books and records of a firm and issue an opinion on the fairness of the financial statements taken as a whole. To perform that work, the outside CPAs rely, in large part, on the expertise of the firm’s Board and senior management. Others have stated that it was Mr. Corzine and his team that made the huge bets, with their clients’ money, on sovereign debt instruments that caused his firm to fail. And, in this case, the CPAs were relying on the former head of Goldman Sachs, a man that Joe Biden called “the smartest guy he knows, in terms of the economy and finance.” (That was not meant as a political comment as I actually like Joe!)

In my book, The Business Zoo, I cite a lesson I learned from investment bankers- “share the pain”- which means all parties to a bad deal should participate in cleaning up the mess. I am guessing that may be what is motivating Mr. Corzine as he is testifies against Pricewaterhouse Coopers or PwC. Poor PwC is having a hard year already with the Oscars and now this $3 billion lawsuit.

Jon Corzine and his team took a huge gamble with their clients’ money and lost. The PwC auditors  provided his firm with accounting advice not investment advice. Boards of Directors, the Chairman/CEO and Senior Management should be the responsible parties when a firm fails.

So, Corzine, the former CEO, pays a nominal fine, but then tries to stick it to anyone else who came near his bad deal. Sometimes, capitalism and our legal system punish the wrong people. Not fair.

News Flash! The Wall Street Journal now reports the lawsuit against PwC was settled out of court for an undisclosed amount. In my opinion, any amount over Mt. Corzine’s meager $5 million fine is still not fair.

I was reminded recently that I had not written in awhile about one of my favorite topics, Management Fraud. Our focus here and in my book, The Business Zoo will concentrate primarily on those people who should know better, people who already make excellent money and who often believe they never did anything really wrong. This is called Management Fraud. Sometimes this can take on giant proportions like kickbacks from suppliers and sometimes it can seem almost like petty cash when it involves travel and entertainment expenses.

As is my practice with potential crimes, we will leave the company and person’s name out to protect their families any further embarrassment. We call this tale: Grooming a Senior Corporate Executive’s Expenses.

As individuals rise to the top of the senior corporate ranks, they get many benefits and privileges. Besides higher pay, bonuses, and stock options, they often are awarded private lunch club memberships, and in the old days, golf country clubs, company cars etc. But this is not enough for some people. For whatever reasons, a certain Senior Corporate Executive working with this company needed more. So the Executive started charging some personal expenses like hair stylists. To make matters worse, the same Executive spread over several expense reports, the cost of a holiday party at their home for their staff. That was against company policy as well. The sum total of all this was very minor compared to the Executive’s salary and bonus. What is also interesting is that the people who dream up and do things like this, are never someone you would expect even if you knew something about Management Fraud.

Expense accounts for senior executives at public companies would make exciting reading, if published in the Wall Street Journal. This actually happened to the, now imprisoned, former chairman of Tyco who charged the infamous thousands of dollars shower curtain. Sadly, senior executives’ expense accounts are often prone to these types of vulgarities. Why? Because for some the higher up in a firm they get, and the more they get, the more they actually believe they deserve.

Pushing your expenses seems like an easy way to get what you believe you deserve. Compounding the problem is this little understood fact: the expense reports for senior executives are reviewed and approved internally by other senior executives! Now some senior people actually do review each other’s expense reports as though they were important; others well, not so much. Sometimes very senior people like a Chairman or CEO, by necessity, have lower level executives review their reports. As CFO at one of my public companies, I reviewed and approved my boss’s expenses. But what should be common knowledge to the Executives at large public companies is that Internal Audit will review or spot check all the senior executives‘ expense reports. And every year or so someone gets caught. And usually for something stupid.

Our Senior Corporate Executive’s improper grooming and party expenses turned a spot check into a multi-year full blown review of all expense reports and departmental spending for the person and their staff. The Senior Corporate Executive and a direct report abruptly left the company “to pursue other interests.” This dreaded corporate jargon phrase usually means they were fired and had to go pursue something else.

Perhaps they learned a lesson and went straight on their expenses. But nowadays with less goodies, like country clubs, I doubt it.

The moral here is simple. Everyone in business and life needs a type of “moral compass” to tell themselves what is right versus wrong. You need to develop this when you are young and starting out and, by the time you are a Senior Corporate Executive, you won’t cheat on your expenses!

I have recently complained about Board of Directors especially in large, public companies.  But occasionally, I have run across some real, value adding, hard working Board members. Here is the story of one.

Cole National and its Misplaced Cash:

Cole National was founded after WWII by leasing spaces in Sears stores to make keys. It expanded over the years to leased optical departments and then to one of the first mall kiosks with their Things Remembered Shoppes, which sold items and performed services like engraving.

Cole was a client of my employer, Arthur Andersen, when they expanded rapidly and lost control of their business. One summer, AA&Co. sent several of us to help Cole out. This led to my first ever, face-to-face meeting with a Board member.

My assignment at Cole was to help with their massive cash management situation. For a month, all I dealt with were their many bank accounts scattered around the U.S. Perhaps we should call it their cash unmanaged system. Why? Due to their focus on rapid growth through acquisitions and new stores, they had lost control of their cash. At the same time due to heavy debt and a retail downturn, they were losing money and their stock price was falling. When this happens, even an often reluctant Board of Directors is forced to got involved.

Cole had not been able to track their cash flow or even reconcile their three hundred bank accounts for over six months. You may think this is a very rare event, but I can assure you that companies often lose control of aspects of their businesses.

So what did we find? Retail stores were being opened so fast that their sales and cash were piling up in some small, remote bank and never being transferred to headquarters. With some of the recent acquisitions, large cash escrow or down payments were placed in bank accounts that were never closed out. There were accounts with large untouched positive balances and some accounts with large overdraft balances and fees. This situation was a textbook on what not to do with cash.

But the worst was the Main Retail account that was supposed to receive all the transfers from the stores. It was not just a cash nightmare, it was an accounting one as well. Cole was trying to account for the sales of their lock and key business separately from their optical and other products by using the proceeds into the overused Main Retail Account.

In the end, we found, in today’s dollars, about $500,000 of cash the Company did not know about; a very big deal when they were having trouble with both earnings and their banks. All of this went into a dozen page report that listed account numbers, misplaced cash balances, and even proposed journal entries to correct things.  I also wrote new procedures for managing and reconciling both the stores and Main Retail account.

Which brings us to the Board of Directors. Our reports were submitted both to Cole’s Controller and their head of Internal Audit. Apparently, the Finance Committee of their Board also received a copy. On one of my last scheduled days at Cole, their Controller comes over and says that a member of their Board Finance Committee wants to meet with me about my report. At that point of my life, I assumed this was like meeting with another client executive, no big deal. I had not yet been trained on the almost mystical importance of such men. Only in my later years, did I learn the vast power of Board wizards and the need to constantly care for and feed them (both data and food).

A meeting is arranged with the Board member. I assumed the two of us would sit down across a desk and chat. But no, the meeting will be in the Board room. And besides the two of us, the Corporate Controller, the Manager of Corporate Accounting, the head of Internal Audit and I am not sure who else shows up. This is before Power Point, so the only media is my dozen page report which everyone seems to have a copy of. The Controller introduces me and asks me to summarize my report’s highlights. The dialogue goes like this:

Me: we found dozens of overdraft bank accounts.

Director: is this true?  The Cole people nod yes.

Me: we found dozens of accounts with untapped cash.

Director(louder): is this true? Cole people nod yes.

Me: in total we discovered over $500,000 in unknown cash.

Director(louder yet): is this true! Another yes nod.

Me: we reconciled 300 bank accounts for 6 months.

Director(pounding on table): I guess this is true! Yes nods.

Me: we wrote procedural recommendations on all this and how to reconcile the Main Retail bank account which will take someone 1 week a month to do.

Director, turning to me, shouting: 1 week that is crazy!

Me: it took me a week the first time, now I am down to three days. The person I just trained will need 1 week.

Director, yelling at Cole people: adopt these new procedures in a hurry and never let this happen again!!

Director, to Me, smiling: good job, thank you.

What did I take away from that first Board member encounter at Cole and what have I learned later after many encounters?

Then, Board members must often get really involved!

Later, not. If this was true, Boards and companies would be much better off. Directors rarely get this involved and, if they do, it’s because there is a terrible crisis.

Then, the Cole managers seemed afraid of the Director.

Later, sadly true. We are told that Management serves at the Board’s pleasure. But fear is not good in a Zoo or a Board room.

Then, Directors yell at Management but are nicer to, and even compliment, outside Advisors, like me.

Later, Directors are often too nice to and influenced too much by Advisors. Directors rarely yell at or confront company managers even when they should. This is especially true in a full Board meeting with dozens of people.

So what are the overall takeaways from this Business Zoo tale? For managers, when you meet Directors, know your material and act confident, not afraid. And for Directors, get more involved in the details, even if its only Cash; it will be noticed by management and can really help.

Fraud, like Grease and several other kinds of bad behavior, that we cover in The Business Zoo, goes back to the beginning of time. The word Fraud has century old roots in both England and France and basically means “to deceive or inflict a loss on others while seeking a personal gain.”

Fraud is a dirty daily business to some although it has often been made glamorous or even acceptable in movies like The Sting, with Newman and Redford deceiving the nasty and deserving Robert Shaw.

But the Fraud I focus on occurs in business and often by people who should know better and already are paid excellent money. This is called Management Fraud. It is so popular an activity that we dedicate a whole Section or Chapter about it in my book.

Big, public corporations like to think they can deal with and often prevent or quickly detect Fraud. To do this these firms put in place elaborate procedures and policies which employees must review and sign. And then to enforce all of this the big companies turn to their version of the police, their Internal Audit group.

There are a million stories about Management Fraud and many involve Internal Audit. Sometimes Internal Audit comes out as a hero and sometimes not.  Here is one short story which I hope you find to be both tender and amusing and yet informative.

Internal Audit and the Dead Cat:

Manufacturing plants are like small cities. They have Mayors (Plant Managers), Councils (Heads of H.R., Finance etc.), Citizens (hourly workers), and a Pest Control Department (A Feral Cat). The Cat is not a normal hire but a walk-in and not a pet but a worker which helps with the local pests (rats). Often the Cat becomes a beloved member of the plant community.

But when Cats age they do not have the same medical coverage or retirement plans as the Mayor, the Council or the Citizens.

At one plant, their beloved cat is old and dying so the Mayor asks his Human Resource person to deal with it. Human Resources people are often called in to deal with the dying of workers or their careers, so this was not unusual. The H.R. person does the humane thing and has the Humane society come out, trap and humanely dispose of the Cat, all for a small fixed fee of $25 which comes out of the Plant’s Petty Cash.

This is not the end of the story since, a few months later, this Petty Cash slip happened to get chosen in a random test conducted by the company’s Internal Auditors. They needed to speak with the H.R. person because in all the sorrow and the funeral that followed for the Cat, the Petty Cash slip was not properly filled out. For the week long Internal Audit at the Plant, the head Auditor kept trying to find the Human Resource person to get the paperwork in order. The meeting never occurred and it was listed as an Exception in the Plant’s Internal Audit report.

The H.R. person for this generous act and general good and humane conduct was later promoted to headquarters.

The moral of this story is that Internal Audit can help a business in many ways including Fraud but they need to focus on what is important and not pursue Dead Cats.