This week I have been exploring the Public Accounting Oversight Board (PCAOB) with Joe Howell, an Executive Vice President (EVP) with Workiva Inc. We have considered how some of the issues addressed by the PCAOB directly impact the Foreign Corrupt Practices Act (FCPA) compliance practitioner in ways that might not seem immediately self-evident. Today I will conclude my series with Howell by considering some of the costs for the failure of internal controls and how auditors, governed by the PCAOB, can help foster and facilitate a best practices compliance program.
There is no materiality standard under the FCPA. This is generally a different standard than internal auditors or accountants consider in a company. However Howell believes their approach is wrong based upon simply more than just a plain reading of the statute itself. This is because Howell feels it is not simply the materiality of the bribe, it may not even be the materiality of the contract that you receive because of the bribe. Howell’s view is that it is much broader as the materiality would be the entire cost that potentially the company could be liable for: pre-resolution investigation, an enforcement penalty and fine, and then post-settlement remediation or other costs.
Howell began by noting that a company must report contingent liabilities in its financial statements, if only in notes. Even if a company cannot estimate these costs, they must be described. A financial statement would be incomplete and actually wrong if they fail to describe a liability when you know that you have one. This means “If a company discovers that a bribe was paid and a fraud was perpetrated and that money was used to pay a bribe, they now know that they have some sort of liability, a cost that they’re going to have to recognize at some point, but they don’t know how much it is yet.”
Howell acknowledges there can be many reasons why a corporation would not want to put such a disclosure on the face of its financial statements; nevertheless, they do need to describe it in the financial statements in order to actually give the reader of the financial information the full picture that they are required to provide.
Any FCPA investigation is going to have a profound cost. If a company desires to take advantage of the new Department of Justice (DOJ) Pilot Program and self-disclose to the DOJ and Securities and Exchange Commission (SEC), it still may result in a risk of a fine, disgorgement of profits and other penalties. Howell added, “then monitoring at the backend and penalties and reputational risk. All of which go together to be material to the company. Even though the bribe was a little bribe, even though the fuse was a small fuse, the bomb is a big bomb. When you see a fuse, notice that it’s been lit, you have an obligation to report that. That’s material. It’s relevant to the reader of the financial statements. Because the fuse is small, you can’t say, I don’t have to report it.”
In an interesting insight for the Chief Compliance Officer (CCO) or compliance practitioner to consider, Howell said that even if you remediate but make the decision not to self-disclose that alone may be evidence that your books and records are not accurate. Take a minute to consider that from the SEC perspective. If your SOX 404 disclosure does not reflect any reportable FCPA incidents because you have remediated and made the decision not to self-disclose, that alone can be a violation of the FCPA.
While Howell believes that such contingencies will resolve themselves over time, he believes it is important to make that immediately available to readers of the financial statements. He went on to state that there are large numbers of diverse constituencies who depend on your accurate financial statements. These include, “your bankers, creditors, as well as your shareholders. You may have relationships that are contractual relationships with suppliers, customers that could be affected by this. You may have contracts with your employees that are affected by this. There may be contracts with other third parties that could be affected or impaired because of your violation of the FCPA, in one instance.”
I was intrigued by Howell’s inclusion of bankers and creditors relying on the accuracy of your financial statements. This is because it is not uncommon now that a loan document or a secondary financing would require a company to maintain an effective anti-bribery, corruption compliance program. I asked Howell if this is something an external auditor would evaluate and, if so, how would they go about evaluating such a loan covenant?
Howell said this could well be important because if such a loan clause were violated, that would be part of the corporate disclosure. Howell went on to note that if an auditor were to become aware that a fraud was “committed and that fraud resulted in resources being used to pay a bribe, the auditor then needs to take a hard look at all the disclosures about the contingencies. If they’re uncomfortable with that, they need to report themselves about what they think that the client may have missed. When fraud is discovered, they cannot keep silent. They have to report it.”
I concluded by asking Howell about the SEC Audit Standard No. 5: what it is and how it ties into the FCPA and the line through SOX all the way to Dodd-Frank. Howell said the precursor to Audit Standard No. 5 was Audit Standard No. 2 which specified what Howell called a bunch of ““thou shalt do” stuff that became very mechanical and it drove people’s costs up and it made people uncomfortable.”
This led to the adoption of Audit Standard No. 5 and a change to a more risk based focus using a principles-based audit standard. The SEC wanted to direct “auditors to those areas that present the highest risk, such as financial statement, closed processes, and controls designed to prevent fraud by management. It emphasizes that the auditor is not required to scope the audit to find deficiencies that don’t constitute material weaknesses.”
Howell believes that bribery and corruption are subsets of fraud and auditors are “required to always disclose fraud, even if it’s immaterial. If they find fraud, and even if the fraud is immaterial, it still means that it could be a failure in the controlled environment that means that they can no longer really rely on those controls. They have to do something else. What they would do is substantive testing, which that means then they would go back and start to look at everything. That’s prohibitively expensive. It takes an enormous amount of time and it results in audits that are not sustainable.”
This means one can then draw even a line to Audit Standard No. 5 and the risks that companies have doing business outside of the US under the FCPA as a risk that needs to be audited. Howell said this means you have to incorporate such an analysis into your FCPA compliance program because if you are doing business in high-risk countries which have a reputation for bribery as a way of doing business and you have operations there that rely on third parties that are securing contracts for you, you have an obligation to build a controlled environment which both prevents, to the best of your ability, mistakes from happening, bribes, and then if one were to happen, to be on the lookout for where that would most certainly and most likely show up.
Howell said this could be a variety of responses, including “transaction monitoring, surprise counts, sending in auditors to actually be part of that control environment to look for all the documentation. It is important to also have that sense of remediation. If you find it, what do you do with it? To whom do you report? What processes are in place? Are they working?”
What are the costs for the failure of internal controls and how can auditors help foster and facilitate a best practices compliance program?Click to tweet
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© Thomas R. Fox, 2016