What Every Internal Auditor Should Know Perspectives of a Chief Compliance Officer

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1 What Every Internal Auditor Should Know Perspectives of a Chief Compliance Officer IIA: November 11, 2011 Jon Rydberg

2 Agenda 1. Opening Comments 2. Weak Infrastructure May Drive Value Destruction 3. Case Study: When Sales Mask Performance 4. Focal Points and Ideas 5. Closing Remarks Disclaimer - This presentation is not about the presenter s current or previous employers. The contents are observations taken from various points over his career.

3 1. Opening Comments

4 1. Opening Comments Objective 1. Internal Audit and Compliance is often misunderstood. Some companies Establish them to check a box. Lack the knowledge to achieve value. Believe they are above it. Believe they are control cops (e.g., Sales Prevention Team ). Believe they are necessary evils, draining cash with no ROI. 2. My objective is to promote these functions as mechanisms to: Establish the boundaries for compliant and ethical business activity; Proactively identify and evaluate emerging risks; and Provide recommendations that enhance infrastructure and protect enterprise value a core responsibility of every executive.

5 1. Opening Comments Definitions and Assumptions 1. Corporate Infrastructure is: People, process, technology Policies, procedures and internal controls Training, measurement and accountability 2. Value Destruction is: Reduction in stock price Damage to customer satisfaction and brand Demoralization of the workforce Fines, penalties, debarment 3. ROI should also be viewed as the lack of Value Destruction.

6 1. Opening Comments Understanding Internal Audit and Compliance Chief Audit Executive Identify and mitigate vulnerability and risk. Serves as an advisor to the Board, CEO, CFO. Integrates risk management into strategy. Chief Compliance Officer Promote standards of conduct. Design policies to prevent improper conduct. Manage company hotline and investigations. Assurance Compliance with policy / law (e.g., T&E) Assurance Compliance with policy / laws (e.g., ITAR) Reliable financial reporting (e.g., SOX) Advisory Efficient and effective operations (e.g., Procure-to-Pay process review) Achieving strategic objectives (e.g., ERP implementation help, due diligence, cost audit) Advisory Business advisory (e.g., International biz design; Executive MBO setting) Policy development (e.g., FCPA, Code of Conduct). 6

7 2. Weak Infrastructure May Drive Value Destruction

8 2. Weak Infrastructure May Drive Value Destruction Share Shock Share Price Declines >30% Approximately 25% of F1000 companies with share shock experienced failures in infrastructure. Can be linked to weak risk management, corporate infrastructure or oversight. Source Corporate Executive Board

9 9 2. Weak Infrastructure May Drive Value Destruction Ten Largest Settlements in Last 12 Months Settlement Costs Excluding Investigation and Legal Support Can be linked to weak risk management, corporate infrastructure or oversight. Source - Nera

10 2. Weak Infrastructure May Drive Value Destruction Ten Recent FCPA Settlements 10 Settlement Costs Excluding Investigation and Legal Support Johnson & Johnson Panalpina (2010) Alcatel-Lucent (2010) Daimler AG (2010) JGC Corporation (2011) Technip S.A. (2010) Snamprogetti (2010) BAE (2010) KBR/Halliburton Siemens (2008) Criminal Fines (Total for All: $2,228) Disgorgement (Total for All: $946) $0 $200 $400 $600 $800 Amounts in $US, millions Can be linked to weak risk management, corporate infrastructure or oversight. Source Resources Global

11 3. Case Study: When Sales Mask Performance

12 Sales 3. Case Study When Sales Masks Performance 1 Time 1 / Increasing Sales Impact Employees are measured on financial performance. Employees are held accountable for not hitting targets, but are not measured on performance in other areas. Tone from the top is founded on trust and there is little mention of Compliance, Ethics or Controls. As the organization s revenue base grows, bonuses are strong, stakeholders are happy and the focus on infrastructure and internal behavior shrinks. Cultural norms develop around heroics. Employees do what is needed to get the job done.

13 Sales 3. Case Study When Sales Masks Performance Stability or Limited Volatility 2 Time 2 / Stability or Limited Volatility Impact Despite limited volatility, success is still strong. Confidence grows. Company goes public. In order to meet Shareholder expectations, new revenue streams are found (new products, new markets, acquisitions). Even less focus on infrastructure as the organization invests its financial and human resources on revenue maintenance or growth. Employees are hired and put into action with little training. Measurement on short-term financial performance becomes stronger. Organization is too busy to think internally. Money is saved by not investing in oversight functions. The business has grown large and complex, outpacing its infrastructure. Yet, margins remain strong due to decent sales and limited internal investments.

14 Sales 3. Case Study When Sales Masks Performance 3 Kaboom! Share Shock Time 3 / Declining Sales Impact Limited revenue to cover fixed costs. Bottomline profits shrink. Pressure is high and even more focus is place on doing what is needed to get the job done. Few written Policies and Procedures govern how work is accomplished. Environment is now ad-hoc and out of control. Employees continue to act through heroics. Mistakes are made affecting cost of quality, customer satisfaction, litigation expense, revenue leakage, cost overruns, injury, etc. Bottom-line profit shrinkage is exacerbated relative to industry competitors because the organization lacks process repeatability, efficiency, compliance and cost control.

15 Business Volume and Complexity 3. Case Study When Sales Masks Performance Management Team Collapsing Infrastructure 1. Investors lose confidence due to slip in profits. 2. Significant investments required to build infrastructure around a sinking ship. 3. The immediate response for oversight and business control is disregarded by tenured workforce.

16 3. Focal Points and Ideas

17 3. Focal Points and Ideas So Where Could Internal Audit or Compliance Have Helped? 1. Identify warning signals. 2. Create efficient and sustainable processes. 3. Mitigate bad behavior. 4. Provide a legal defense. Consider the following benefits. - Controls drive accurate financials Keeping officers out of jail: - Controls drive ethical behavior Avoiding $335m of FCPA fines: - Controls prevent duplicate payments Enhance working capital: - Controls facilitates working systems Mitigating system re-work: - Controls limit workers compensation Eliminating safety issues: - Controls ensure inventory accuracy Minimizing production delays: ROI = Positive!

18 3. Focal Points and Ideas Balance Internal Audit According to Your Needs Foresight (Strategic) Where is this process going? Can it scale? Should new technologies be considered? Insight (Proactive) How can the process, be enhanced? What are other companies doing? Can we further leverage our technology? Oversight (Reactive) Are we operating as planned? Are the processes and controls operating effectively? Are policies being adhered to as intended? Spectrum of Capability Confidential, Not For Re-distribution 18

19 3. Focal Points and Ideas Use Internal Audit s Risk Assessment for Strategic Foresight 100% of Boards Want Insight Into Emerging Risks, 51% Are Provided Them Sample Emerging Risk Chart Confidential, not for re-distribution

20 3. Focal Points and Ideas Internal Audit can Benchmark Your Infrastructure Maturity Level Distinguishing Factors Capability Description Capability Characteristics Increased Quality 5 Optimized Continuously Improving Process Continuous Improvement Continuously improving controls enterprise-wide Proactive improvement of processes & controls, based on costs Enterprise-wide risk strategies Use of statistics data to analyze & improve costs, performance, & risks Formal & flexible cost / benefit analysis Best practices identified & shared across organization Application processes and technology are fully integrated organization wide 4 Managed Predictable Process Quantitative Risks managed quantitatively enterprise-wide; Chain of accountability Objective is process control of outputs Detailed statistical measurement & use of key performance indicators Cost & cycle times well known Early-warning systems, risk analytics, and contingency preparation Experienced personnel with requisite knowledge & expertise in place 3 Defined Standard, consistent process Qualitative / Quantitative Policies, process and standards defined and institutionalized; Chain of certification Proactive management & flexibility Standard roles & training Standardized processes company-wide Stable & measurable processes Standards & verification mechanisms Consistent reporting & reporting of exceptions & near-misses 2 Repeatable Disciplined Process Intuitive Process established and repeating; reliance on people continues; controls documentation lacking Management objectives & planning Some documented policies & procedures, signs of implementation Stability increased Organizational knowledge & training Clear accountability & understanding of roles/commitments Increased Risk 1 Initial No Process Evident Ad Hoc / Chaotic Control is not a priority -- Unstable environment leads to dependency on heroics Unpredictable & subject to firefighting & crisis management Little or vague documentation/policies Highly dependent on key individuals & heroics Instability, especially during crisis Inconsistent reporting mechanisms Undefined roles & accountability 20

21 3. Focal Points and Ideas Utilize Internal Audit Software for Proactive Risk Management 21

22 3. Focal Points and Ideas Keys to a Successful Internal Audit or Compliance Function Rollout Tone From The Top Public announcement. State the purpose (compliance, process improvement, mixture). Accountability Without it, your investment is meaningless. Establish a structured reporting process to Management, the Board, and back to employees! Establish Defined Programs (GE examples) Driving culture has to be the results of defined, tangible programs. Budget Appropriately Cultural programs: Leadership engagement; Risk assessment; Training; Communication; Evaluation Compliance programs: Ownership by an executive (don t blame the staff, legal or compliance). Assess (list the regulations we must comply with). Resource (hire and assign domain experts) Relate (build it into the business process, don t outsource it). Balance your spend and budget with GAIN. Establish an amount that you can stomach without reason to adjust.

23 3. Focal Points and Ideas The Key to Being Compliant Seven Pillars of the Federal Sentencing Guidelines Compliance Program Leadership Assign an independent owner, reporting to the Board Develop values, culture and tone Standards and Procedures Create a structured policy set and Code of Conduct Exclude Prohibited Personnel Documented background checks of third parties, channel partners and suppliers Training and Communication Online and in-person training Train third parties Audit, Monitor and Report Develop a rotational audit plan, up to 2x per year Enforcement and Discipline Reward and discipline employees Response and Action Establish a corrective action process Aggregate compliance and internal audit findings

24 4. Closing Comments

25 4. Closing Comments An Exercise for Your Organization 1. List the seven features that the Federal Sentencing Guidelines expect within an organization s Ethics and Compliance Program. 2. List the features of your Ethics and Compliance Program. 3. List the actions that each department has taken to support your Ethics and Compliance Program. 4. Is your Internal Audit function aligned to your Strategic Objectives? 5. Have you benchmarked it against GAIN or other Companies? 6. Have you considered all three ranges of the IA spectrum? 25

26 4. Closing Remarks Remarks from Best of Breed Companies Area Remarks Activities Ethical and compliant behavior Culture and Ownership You can do everything right for 20 years and kill your reputation in 5 minutes. Warren Buffet (not present) Never Hide what has occurred. You only have once chance to tell the truth; Failure to act with total transparency risks your entire brand. Hyatt Employees like to work at a company that is consistent with its own values General Electric Differentiate between we are an ethical Company and being able to provide it in a defined ethics program. Measure ethical conduct. A good compliance program is effective if you take action when someone does something right or wrong - UBS Measure ethics in executive MBOs Google It is very easy for the CEO to set the tone, he/she only speaks to 5 people. The middle management layer is critical to changing a corporate culture. Accenture How do we get the business to own compliance and ethics? First we spoon feed them, then we ram it down their throats Microsoft Hold an annual Company awareness meeting. The first award should be on integrity and ethics. Middle layer should be appointed and rewarded as drivers. 26

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