Power With The Powerless

Might is Right?

Might is Right?

Durga Shakti Nagpal honoured the goddess she is named after. The 29-year-old IAS officer is in eye of the storm as she took on the sand mafia in Utter Pradesh. It was said the political party got benefits from the sand mafia. The Chief Minister Akhilesh Yadav suspended her on the grounds that she ordered demolition of a mosque wall. Her actions could have created riots.

The Muslim community hasn’t taken kindly for being used as an excuse. They have denied any such action and stood by Durga, stating that she is a great officer. Punjab State Deputy Chief Minister Sukhbir Badal has invited her to join back her own state. He said that Punjab state appreciates honest officers and the government will stand behind them.

So why has Akilesh Yadav’s carefully planned manoeuvre to show his political might fallen flat. It is because he still has old school ideas of power. He literally inherited power from his father, and though young is still using old tactics based on incorrect assumptions.

1.      Witch Hunting is Not an Acceptable Game

The ancient tactic of using a woman as a sacrificial goat to quiet everyone by creating fear and terror is no longer working. The number of Indian women crusading against corruption and crime is increasing manifold. Women are clearly saying they don’t get weak kneed by power and money. They hold ground and fight back from a higher moral standing. They show the powerful in their true character. The public nowadays doesn’t support witch-hunts and stands by strong women. The educated public is capable of identifying the true heroes and leaders.

2.      Attempts to Divide & Rule on Race & Religion Backfire

Using religion and race to divide people and rule isn’t an effective strategy anymore. With a black half-Christian-half-Muslim man as American President, and a white Italian Catholic woman as party president of Indian congress, the message is clear. Race, gender, age, and colour don’t matter in leadership positions. People follow the leader with the best ideas and capability. Belonging to a certain community may not get any followers now from the educated masses.

3.      Absolutely Impossible to Curb Public Opinion

Technology and globalization has put everyone on an equal footing. Previously a few could control public opinion as they had the contacts and money to influence media. However, social media has given a voice to the public. The general population forms its own opinion. It has also made the old media houses more honest as they lose circulation with carefully planted stories and politically motivated views. With social media, anything can go viral; there are no safe zones to hide dirty deeds. The transparency makes corrupt powerless.

4.      Autocracies are Dead

The changing perceptions of power have made old strategies useless. Earlier leaders could say my way or highway. Some said my way and my way, they wouldn’t even allow a person to take the highway. However, autocracy is no longer a popular leadership style. In the last decade, the number of countries with autocratic regimes has decreased and democratic governments have increased. Business and political leaders need to show democratic and consensus building styles. Surveys show that autocratic leaders – business and political – are losing their jobs at a higher rate than democratic leaders. Hence, a display of muscle power in public domain shows the leader in poor light. Using dictatorship styles will get the dictators in soup rather than the targets.

Closing Thoughts

Power has shifted to the powerless. With the changing society, technology, and economic order, one is likely to see new forms of political power structures in governments and organizations. We are at the threshold of a new era of power dynamics. From a risk management perspective, any risk mitigation policies developed based on old power structures are likely to fail. Hence, risk managers need to look at leadership strategies and related risks from a different lens.

Here is to new beginnings with power in the hands of the people. We can hope the 21st century will bring glory to the masses. Finally, each person can say that wish to live their life on their own terms. I am dedicating to my readers one of my favorite songs – My Way by Frank Sinatra. It beautifully conveys the message.

Risk Management Lessons Learnt in 2012

For risk managers 2012 was an eventful year. The frequency of ethical breaches, regulatory failures, operational disasters and natural calamities ensured that risk managers have their hands full and are not going to run out of work in 2013. In effect, risk management function is at a strategic inflection point and is facing disruption risks. Globalization, rapidly changing technology, economic recession in Europe, political turmoil in Middle East, growth of emerging markets and global warming has changed the risk landscape. Throw out of the window the old stance of managing risks by implementing controls and focusing just on financial processes and operational risks. The 21st century demands risk managers to focus on strategic, cultural, leadership and human resource risks. This is a bold statement to make, so here are my reasons for making the same. Do you think I am on the right track?

1.      Banking Sector Culture Needs Overhauling

Though I have not done a tally of regulatory fines paid by banks during the year, the numbers are awesome. It the status quo remains the same, paying billion dollar fines will soon become fashionable. The way bankers are behaving, if culture does not change, they will start a competition on who pays the biggest fine and gets away with it. It is clear that bankers gave a lot of lip service of changing to the public after the financial crises. Nothing much changed and they remained complacent with their ability to escape any personal loss due to reckless behaviour. Even with fines, it is investor loss with hardly any personal responsibility. 2013 will determine whether bankers can do the right thing for the right reasons in the right way.

2.      No One is Too Big to Go to Jail

2012 showed that breaking the law isn’t an option for top guns. Big names, for instance, Rajat Gupta and Rebecca Brooks realized the arms of law are long enough to reach them. The psychology that it only is a crime if one gets caught needs to change. A connection even with the Prime Minister doesn’t insulate a person from being held legally accountable.

The downside of capitalism is that business ethics are put on a back burner in pursuit of profitability. 2013 will see the trend of businesses focusing on building ethical cultures.

3.  Senior Management Fails At A Higher Rate

Throughout the year, one heard senior managers being fired for poor performance, regulatory breaches, criminal acts or inability to keep their pants zipped. Tragic but true, that senior managers are failing to walk the talk and assume leadership is about playing power games. They ignore everything in pursuit of a bigger pay packet. It isn’t that leaders didn’t fail previously, but now they make headlines at global level.

Additionally, social media and increasing percentage of women in the workforce has made old management and leadership styles redundant. Flatter organization structures are replacinghierarchical styles. Collaboration is in focus rather than competition. Boomers are leading most organizations, and their style of leadership is passé. Hence, in 2013 we are going to witness higher leadership failures unless organizations start managing leadership risks.

 4. Regulators Take A Tougher Stance

Worldwide regulators have changed their stance. Be it Comptroller and Auditor General of India, Department of Justice of USA or Financial Services Authority of UK, regulators are beating the drums for better compliance. From asking the biggest names in banking to give explanations to holding government accountable for incorrect decisions, they are leaving nothing out of the ambit. They are leading the path for risk managers to follow. In 2013, we are going to see a spate of disclosures from regulators.

Closing Thoughts

Whether we see the banking failure reports, or other aspects of business, risk managers knew and understood the risks. However, they decided to play it safe and not bell the cat. Challenging and confronting business leaders at the expense of ruining ones career can be a tough decision. One avoids the decision, especially when, the lines of accountability state that final responsibility of managing risks lies with the business leaders. However, in the times ahead risk managers won’t have this luxury. They will have to stick their neck out to ensure organization stays legally compliant and manages risks optimally.  I don’t know whether this makes risk managers happy. In my view, in 2013 we should take it up as a challenge and change the dynamics of the risk management function.

Wish you and your loved ones a very Happy New Year.

Do corporate awards misguide public?

I want to ask you a few questions. Have you ever thought of a company as a good investment prospect after seeing the awards it has received? Do you form a favorable opinion when a business leader receives an award for best CEO or Entrepreneur? What about when a company receives an award for corporate governance, innovation or great place to work? We assume the selection was unbiased and evaluation criteria were stringent. Hence, we form a positive image of the winner. Nothing succeeds like success.

Now what happens when we discover that the leaders whom we have put on a pulpit have feet of clay? Recently, a Miami businessman, Mr Claudio Osorio, former president of Inno Vida Holdings was arrested for a $40 million fraud. In 1997, Ernst & Young had awarded Mr Osorio “Entrepreneur of the Year” title for CHS Electronics, a company he owned. Amazingly, in 1999 CHS Electronics settled a class action lawsuit brought by its shareholders. The next year the company became bankrupt. Doesn’t this raise questions on jury’s decision and selection criteria for giving the award?

Closure home, the story is the same. Ramalinga Raju, previously the CEO of Satyam responsible for conducting the biggest corporate fraud in India, was awarded Ernst & Young Entrepreneur of the Year Services Award in 1999 & 2007 (which was withdrawn later). Other awards received by him were – Dataquest IT Man of the Year Award 2000, CNBC’s Asian Business Leader – Corporate Citizen of the Year award in 2002 and Golden Peacock Award for Corporate Governance 2008 (withdrawn later).

According to my understanding, the Indian scene for corporate leadership awards is quite easy to understand. There is a group of 25 prominent business leaders from whom the 6-7 jury members are selected. During the year, in the 5-6 corporate award functions at least 2-3 jury members are common. The same group of 50 companies receive the awards year on year. Each function distributes 9-10 awards. Around 7-8 awards are given to this group and just a couple of new names are added. In the newspapers, a detailed write-up is given of the jury interactions for selecting the awardees.

One might say that these are the top performing companies and CEOs; hence, they deserve the awards.  The other could be that these CEOs have excellent public relations teams working to get the business leaders and companies nominate. However, in my cynical view it appears as a game of corporate musical chairs where business leaders pat each other on the back and allow entry to a few in the exclusive club. I am not joking; a recent award function separated the members of the exclusive club from the non-exclusive business leaders by demarcating the area with a red rope.

Giving an award may not be big deal. However, it becomes serious when awards of corporate governance excellence or best entrepreneurs are given. People assume that after being evaluated by peers and benchmarked against best practices, these leaders and companies are best in the pack. A small individual investor relies on this information when making an investment decision. Can we count the number of investors who traded in Satyam shares believing it to be an excellent company? These investors lose money and sometimes their whole savings. Hence, the ethics and integrity of these awards must be maintained at all cost.

The corporate award functions should not become similar to the Bollywood award functions. The common perception of Bollywood awards is that whichever hero or heroine performs on the award function gets an award. Just a few awards are given on actual box office performance. I don’t have any information of behind the scene activities of corporate award functions. However, investors will lose faith if the Bollywood method is followed.

Closing thoughts

In my view a government body, something like SEBI should evaluate the criteria of the bodies giving awards. It shouldn’t become a brand building and sales exercise to get clients and investors. Hence, only a few select organizations should be allowed to distribute awards. Periodically, the government body should conduct a review. Moreover, the government body should evaluate the cases of awards given incorrectly and recommend legal action where required. What do you think?

Two Lessons from Purti Group Investigations

Nitin Gadkari, the BJP President, is under the scanner in respect to his Purti group. The allegations are that multiple layers of companies were created with numerous ghost investors. Some of the companies exist only on paper and the directors are all employees of Mr Gadkari. The Income Tax department and the Registrar of Companies have commenced investigations after the stories appeared in the media. I have a couple of questions about the whole thing.

1.     Unqualified Directors

Until fourteen months back, Mr Gadkari was the chairman of Purti Power and Sugar Limited (PPSL). Presently Mr Sudhir Wamanrao Diwe, Mr Gadkari’s personal assistant is the managing director. Moreover, as per media reports “four directors of Purti’s investment companies  - Kawdu Zade, Manohar Panse, Nishant Agnihotri and Sagar Vikaskotwaliwale – are either close associates or employees of Gadkari. While Zade is the accountant of Gadkari’s household, Peens is his driver.” Additionally, the four were directors in 16 corporate companies holding major shares in PPSL before 2010.

A fundamental question out here is why the director’s profession is a big deal. As per company law, any one can obtain a Director Identification Number (DIN) and be a director of the company. The DIN application requests for the residential address of the person. No details regarding professional qualifications or background are required.

The joke doing the rounds is that every driver now wants to be Nitin Gadkari’s driver. Seriously speaking, the onus of responsibility of appointing well-qualified directors rests with the promoters. It is their choice. In most cases, directors are friends and acquaintances of Chairman or CEO. Hence, the question is should the Corporate Laws be modified to ensure the quality of directors appointed?

2.     Fictitious Addresses of Companies

The second issue is that a number of group companies of PPSL are not operating from the addresses given to the Registrar of Companies. IT department visited the addresses in Mumbai including Damji Shamji Trade Centre at Vidyavihar (West), Dube Chawl at Andheri Kurla Road, two locations at Fort and Gupta Compound at Thane.

Further, as per Times of India – “four shareholding companies — Seven-Eleven Sales and Marketing Pvt Ltd, Ashwami Sales and Marketing Pvt, Nivita Trades Pvt Ltd and Rigma Fintrade Pvt Ltd — were shown as operating from the Vidyavihar office. Interestingly, at least three of these offices had earlier shown a room at Dube Chawl at the Andheri Kurla Road as their address. TOI’s investigation had found that the offices never existed in the chawl.

TOI had earlier reported that some two dozen companies had unverifiable addresses.”

As per the Companies Law while getting incorporated promoters have to give the correspondence address till its registered office is established. Secondly, the law states:

“(1) A company shall, on and from the fifteenth day of its incorporation and at all times thereafter, have a registered office capable of receiving and acknowledging all communications and notices as may be addressed to it.

(2) The company shall furnish to the Registrar verification of its registered office within a period of thirty days of its incorporation in such manner as may be prescribed.”

Since the companies were incorporated a decade back, the basic question is where the communication was sent from the Registrar of Companies. Secondly, at the time of registration and future years why the Registrar of Companies missed out that a multi-crore business is being run from a chawl . Is that not sufficient to raise alarm bells? How did the auditors of the company approve the corporate governance standard and where did they audit the books?

This would not be a one off case. There would be numerous cases where the registered address is fictitious despite that fact that Company Law prescribes serious penalties for furnishing incorrect information at the time of incorporation. Hence, the question is why are the review and investigation procedures at Registrar of Companies not improved to reduce wrongdoing?

Closing thoughts

The case has highlighted the prevailing malpractices in the corporate world. As the investigations are going on more dirt will be uncovered. However, the government instead of making a Congress – BJP power struggle, should introduce legal processes and procedures to curb these misconducts. The government should modify the new companies bill to address these loopholes. Lastly, the auditors liability for signing off on corporate governance standard of the company should be clearly mentioned when the basic tenants are not met.

References:

I-T heat on companies linked to Nitin Gadkari

Winner of the Competition of Bullshit Quotient Book

Thank you all for participating in the poll and the competition held in the post “A Book Review – Bullshit Quotient“. Over a 100 people voted and mostly in favor of the views expressed by the author Ranjeev Dubey. Ranjeev has personally gone through the comments and chosen a winner. He has also expressed this thoughts on the various comments. Read below, as I am sharing an unedited version of his opinion.

My thought as I read through the thoughtful comments posted by your followers was mainly at the high level of comprehension here. Why we nevertheless allow this endless repetition of culpable double speak is a moot question. Why this clear understanding of the reality on the ground does not translate into a program of change is another moot question. I can draw your attention to the following nuggets that I particularly liked:

“The business of the company is to deliver value to the stakeholders/shareholders. Everything else is incidental. All the stuff about delivering value to customers is BULLSHIT. - M Seshagiri Rao:

“Small practices often have no audit trail. Accountability is ensuring that you understand and carry out the actions of the law, with ethical and moral actions. So, the laws are there, [but] the government is in the hands of those who thrive on power, regardless of having the right to vote, that doesn’t even matter…”- Joanne McNamara:

“As a cynical private investigator I have found that the bigger the lie, regardless of the circumstances, simply means that there are more person involved.”- Jeff Moy

“To add to the misery, a nation in need of an inspiring dream, is fed the empty corporate drivel”. - Amey Kawale

But at the end, the prize goes to the one who goes beyond the points made, to the next level so to speak. And for me, the winner is:

“Commercial organization sometimes fail to realize (or take the ostrich approach to the fact) that they don’t exist in a vacuum, but within an ecosystem where the (mostly competing) interests of companies, customers, employees, regulators, environment and the larger society are required to be optimized. This was the stated (though in a different way) objective of the concept of Trusteeship, which sadly has gone out of the window gradually after Indian independence.” – Deb.

Thank you all, and especially, thank you Debashis

Rajeev Dubey “

The winner of the competition is Debashis Gupta. Congratulations!

Debashis please email your address to me and we will send you the prize.

Performance Appraisal for Risk Management Functions

Think of climbing into an aircraft that doesn’t have an aircraft control system and the Air Traffic Control rooms don’t function properly. Would you be willing to go for a free ride in the plane?

If I say risk management functions play the role of Air Traffic Control rooms and provide the relevant feedback to the business, you would mostly agree. But what are the systems in place to see whether the risk management functions are fulfilling the role of Air Traffic Control rooms properly. If Air Traffic Control rooms fail, the planes crash and the same happens in business. Isn’t then performance appraisal of risk management functions critical?

Generally, I have seen risk management functions do an appraisal within the team and sometimes take feedback from senior management. This is despite the fact that in most surveys conducted, the business teams respond that they face challenges with risk management functions and highlight quite a few shortcomings. As the year is ending, the functions would be busy preparing annual budgets and strategies. This would be the right time to obtain feedback and do a proper evaluation.

Let us take an example of the fraud department and study the process of performance appraisal for the department.

1.     Senior Management

Get uncensored honest feedback from the senior management. Not the form filling one, where meets expectations means haven’t committed a big blunder till date. Check whether senior managers are ticking the appropriate boxes to keep the risk management function out of their hair for another year or is it genuine support for improvement. Ask the probing and difficult questions to the audit committee and CXO level:

a)     Does the risk management function help you to perform better?

b)     Did the risk management function add value to the business during the year?

c)      Where you worried during the year that some unpleasant risks will appear that have not been identified before?

d)     Does the risk management function makes you feel confident that the business is running on course?

That will give out a message to senior managers that the function is geared to take up a bigger role in business and partner with them for success.

2.     Business Teams

Though the risk management functions issue reports relating to operation risks, the feedback of business teams is restricted to obtaining their replies to the observations made in the reports. Risk management functions rarely go back to business teams for an evaluation. One way is to conduct a yearly survey to obtain business teams assessment on performance. The other way is to incorporate a value scorecard system. This ensures that after every assignment,  the business teams’ feedback is obtained in the value scorecard. This enables the function to take corrective measures promptly to provide better service in the next assignment. Some of the questions to ask are:

a)     Did the risk management assignment offer value to your business operations?

b)     Did the risk management teams partner with you to solve your concerns? For instance, in a fraud investigation, did the report help them identify the suspect, and give a solution to prevent future frauds?

c)      Did the risk management team give you a practical solution or recommendation to mitigate the risks?

d)     Do you get prompt replies to your request for help or advice?

Build a value scorecard with 10-15 questions. A periodic assimilation of the responses will highlight the strengths and weakness in performance of the risk management functions.

3.     Other Risk Management Functions

If one wishes to breakdown the silo approach to risk management, then each risk management team should be evaluating and giving feedback to the other teams. For instance, a fraud department should get feedback from compliance and business ethics function.

This is the most beneficial of feedback, because other risk management teams actually understand the nature of work, issues and challenges. Obtaining feedback opens doors for sharing best practices and aligning the work. With numerous functions managing business risks, there are some un-addressed risks as each department assumes that the other is fulfilling the responsibility. Hence, some relevant questions need to be asked. Here are a few examples:

a)     Do you believe we are complimenting your work or are working at cross purposes?

b)     Do you get information on our work to tie up and give a joint strategy to address related risks?

c)      Do our teams collaborate well together on joint projects?

d)     Do we share our methodologies, knowledge and best practices to benefit each other?

Working in isolation isn’t going to help the function, other teams or the business. Hence, taking feedback from other functions is really important.

4.     Risk Management Team

Doing a fair and honest evaluation of team performance is of paramount importance. If possible, implement a 360 degree performance evaluation system. A top down evaluation system will not work for risk management function, as most of the interaction with business teams is done by middle and junior managers. They are aware of business team attitude towards risk management. Even the office rumour mill gives some useful information of acceptance and popularity of the risk management function. Some of the questions the team should be asking are:

a)     Are we viewed as business partners by operation teams and do they think we add value to their business?

b)     Are we doing the best possible work to mitigate the risks?

c)      Are we using standard tools, methodologies and knowledge to give the best possible service to business teams?

d)     Do we have a good talent pool that understands the business and associated risks?

Unless the risk management function does an honest self-evaluation, it is unlikely to find the gaps and improve. Hence, a good deal of time should be spent on it.

Closing thoughts

A good performance appraisal is possible after assimilating the information from all four sources and asking a lot of probing questions. Rather than shy away and get defensive it is best to take the feedback in positive light. Without feedback the function is directionless. Here is a small video pf HCL on performance appraisal. It brings the point home.

A Book Review: Bullshit Quotient

Enter the competition below to win the book.

Ranjeev Dubey’s recently published book “Bullshit Quotient” (I am literary correct, and haven’t resorted to swearing on my blog) pulls the wool from the eyes. The lines in the introduction pages are – “Absurdly, in our cultural fabric, spotting the little lie is a skill called wisdom; spotting the big one is a sin called cynicism”. Hopeful idealists, who believe the world will become a better place to live, will be disillusioned and disheartened reading this book. The jaded cynics will find it provocative, amusing and ruthless. If you are willing to get your rose-tinted glasses peeled off, then read this book.

Ranjeev, an attorney by profession, wrote this diatribe on Indian corporate, legal and social world to call a spade a spade. It is rare in India, that an author chooses brutal honesty over the delicate footwork of political correctness and diplomacy. Below are my three main takeaways from the book.

1.      The Cost of Economic Growth

Fittingly, Ranjeev has narrated the excessive cost of industrialization paid by economically backward and tribal communities (Adivasis) of India. Government on the pretext of acquiring land for development, irrigation etc. has made millions homeless. Without farming land and an education, these poor people have become slum dwellers in cities, and do menial tasks to make a meagre living. Those outraged by the injustice meted out to them, have joined Naxalite groups and terrorist organizations. Their anger has led them to a path of self-destruction, as after a couple of years they are either shot down in a police encounter or spend their life in prison. The urban class is completely apathetic to their plight,  as they are focused on catering to their latest self-indulgence.

Nearly one-third of Indians live below poverty line, and India cannot become a powerful nation unless these poor people start earning  a reasonable standard of living. Two big ones are required to change the situation. The anarchic land acquisition act needs to modified to give a fair price to land owners. Political will has to be strong to re-locate the displaced people.

2.      Dependence of Independent Directors

Ranjeev has raised the same question as I did before – Are the independent directors really independent. Ranjeev’s strong opinion  is – “In truth, independent directors are wall flowers, perching uneasily on the tenuous board seat, good to topple any time the promoter choses. They can’t protect themselves, leave alone the small shareholder”.

Aptly described; the independent directors appointment and continuance is dependent on the good will of the promoters.  They are not in a position to take a strong stance, as they will be labelled troublesome and jeopardize other appointments. Even well-reputed industrialists sitting on other company boards restrain from rocking the boat. In the elite club, no one wishes to spoil the business equations. Hence, it is just a mirage that independent directors are the bastions of corporate governance and will defend small investor interests.

3.      Auditor Role in Fraud

Objection, my lord; here, I beg to differ. Ranjeev has rightly pointed out auditors primarily responsibility is not to detect frauds. Auditors cannot be held responsible if a fraud remains undetected. But there are two statements, where my readers will have to defend the auditor’s reputation. Below are the extracts:

“It is not the auditor’s job to get into the details of books, records and documents. It follows that the auditor’s only job is to take a leisurely glance at the papers of the company puts before the auditor while daintily picking the sumptuous kebabs over the working lunch at the company’s office.” The lunch dig is true, it happens in India but auditors have to bury their noses in the books of accounts of the company.

The second one is more disparaging –

“He does not understand the company or its business, does not understand the environment in which the company operates and does not understand what is going on in it. His job is to look at the books and create more papers. Auditing is about reconciling paper trails, not truths.” Whoa, if an auditor hasn’t got his fundamentals right, then most probably he is delivering this poor quality work. Auditors need to figure out how to break these negative stereotype images and get appreciated for the value they offer.

Closing Thoughts

As we are given a choice between being an optimistic idealist and pessimistic cynic, I choose the former. Idealists are happy, cynics’ worldview is miserable. Nonetheless, we can’t ignore the atrocities, injustices and differences in our world. An idealist is better equipped to bring about a change, when the plans are grounded in reality. If reality stinks, we have to acknowledge and accept it before we devise a strategy for change.

This book describes the smelly portions of our society, which we want to close our eyes, ears and nose to. Besides it, the book has amusing wordplay. Here is line I liked – “Of all the bibulous ballyhoo that emerges from the loquacious lips of corporate kookaburras, the weirdest is the idea that the business of a company is delivery of value to its customers.”

Win the Book – Enter the Competition

Share your opinion here. If you agree or disagree with Ranjeev, come forward. You can win. Ranjeev will select the best comment and the book will be yours. Ranjeev has also offered to give a response to your comments. His response and the best comment will be posted on 17 October. Mind you, you will get a good defense; he is an attorney by profession.

You can visit Ranjeev’s website at www.ranjeevdubey.com

Auditor’s Communication With Audit Committee

Finally, the US audit committees will be getting the full picture of the financial statements from the auditors. The Public Company Accounting Oversight Board (“PCAOB” or the “Board”) of US  is adopting Auditing Standard No. 16 – Communications with Audit Committees. It is aimed at improving dialogue between auditors and audit committees to enable better oversight and financial reporting.

The scope of communications has increased from the previous practice of discussing – accounting policies, procedures and estimates, quality of financial reporting, unusual transactions and significant auditing and accounting matters. It covers a  more matters that will increase clarity.

Previously the status of communication was aptly described by George Bernard Shaw’s quote – “The single biggest problem in communication is the illusion that it has taken place.” Audit committees in my view lacked critical information . Secondly, as there is a shortage of financial experts (just one is mandatory) they were in no position to analyse the details of the financial statements. It was easy to hide artistic accounting from them. This standard will reduce communication gap between the auditors and audit committee.

In India, though the roles and responsibilities of the auditor and audit committee are defined in the Listing Agreement of SEBI and New Companies Bill, the nature, content and quality of communication is not specified. It mandates audit committee should meet at least four times a year, however doesn’t shed light on the quality of discussion to take place. The audit committees in India, are required to look into loan transactions, related party transactions and a couple of other things. These requirements are not mentioned in the list below.

In brief, as per Auditing Standard No. 16 the auditor would be required to communicate the following to the audit committee:

a.  The terms of appointment and engagement, objective of the audit, and responsibilities of management and auditor.

b. An overview of the overall audit strategy, including timing of the audit, significant risks the auditor identified including risk assessment procedures, and significant changes to the planned audit strategy or identified risks;

c. Information about the nature and extent of specialized skill or knowledge needed in the audit, the extent of the planned use of internal auditors, company personnel or other third parties, and other independent public accounting firms, or other persons not employed by the auditor that are involved in the audit;

d. The basis for the auditor’s determination that he or she can serve as principal auditor, if significant parts of the audit will be performed by other auditors;

e. Significant accounting policies and practices including changes. Reasons certain policies and procedures were considered critical and the effect on them in respect to current and future events. Effect of policies and disclosures in controversial area and where there is lack of authoritative guidance.

f. Situations in which the auditor identified a concern regarding management’s anticipated application of accounting pronouncements that have been issued but are not yet effective and might have a significant effect on future financial reporting;

g. Description of process for developing critical accounting estimates including the significant assumptions. If any significant changes are made in the process or estimates.

h. Significant unusual transactions with policy and procedures used by management for accounting unusual transaction;

i. Quality of financial reporting including whether auditor identified bias in management’s judgement about the amounts and disclosures in financial statements. Assessment and conclusion of critical accounting policies. Auditor’s understanding of the business rationale for significant unusual transactions.

j. The results of auditor’s evaluation about financial statement presentation. Whether the reporting including form, content and arrangement are in conformity to standards.

k. Difficult or contentious matters for which auditors consulted external consultants

l. Auditor is aware management consulted external sources, the auditors should also give their opinion;

m. The auditor’s evaluation of going concern;

n. Uncorrected and corrected mis-statements including those discussed with management;

o. Material written communication with management

p. Disagreements with the management

q. Departure from the auditor’s standard report;

r. Difficulties encountered in performing the audit, and

s. Other matters arising from the audit that are significant to the oversight of the company¡¦s financial reporting process, including complaints or concerns regarding accounting or auditing matters.

Closing thoughts

The various auditing and accounting standards in India cover most of the points mentioned above. The auditor is required to ensure conformity to the standards and comment on the same if there are variances. However, there is no specific guideline for communication between auditor and audit committee. As the US standard just defines minimum communication requirements it would be beneficial to formulate and adopt a similar one in India and other countries. It will ensure a specific level of interaction with auditor and audit committee is maintained and the audit committee makes informed decisions.

What do you say? Should there be a global standard for communication with audit committees? What other steps can be taken to reduce barriers to communication between the auditor and audit committees?

References:

PCAOB Adopts Auditing Standard No. 16, Communications with Audit Committees, and Amendments to other PCAOB Standards

 

LIBOR Scandal – What Went Wrong?

This week Barclays Plc made banking history for the wrong reasons. The unheard occurred – the chairman, chief executive officer and chief operating officer – all resigned within one week. While chairman of Barclays, Marcus Agius took the blame saying “the buck stops with me“, initially Bob Diamond said the incident was “inappropriate“. An understatement or lack of adequate vocabulary for describing a manipulation with such huge impact on the financial markets? LIBOR is used as a benchmark for prices of approximately $ 350 trillion of financial products. British and US authorities fined Barclays $453 million!

In the parliamentary hearing yesterday, Mr. Diamond did modify his viewpoint and said “behavior is inexcusable“. In the hearing, Mr. Diamond implicated Bank of England and the Financial Regulatory Authority. With a dozen more banks under investigation, this story of rigging interest rates  isn’t going to blow over. It is just going to get murkier with time.

Watch this video to get an inside view on the procedures for calculation of LIBOR and the lack of monitoring by the regulators. Some speakers have given volatile views, but these are definitely worth listening in case of such a serious breach of business ethics.

In the last couple of months, titans of banking industry are facing the public ire. First Jamie Dimon was called in for questioning by US senate, yesterday Bob Diamond was questioned by UK parliament. The winds are blowing in a different direction; public is outraged by lackadaisical attitude of bankers towards ethical practices. Since the financial crises, many have written about the need to change culture within the banking organizations. However, from the frequent scandalous news stories, it doesn’t look that the wizards of the industry are understanding the social strategic inflection point.

With senior bankers’ ambition to join billionaires club, even the best minds have developed blind spots. The ambition is for more and more money; they have forgotten that more is not always better. We need banking CEOs to have the ethical mindset of Dalai Lama to bring about a positive change in the industry. Is it possible, what do you say?

References:

Barclays CEO Bob Diamond Resigns After Rates Scandal – Business Standard

Performance of Indian Boards

The board of directors have the responsibility for steering the organization in the right direction and guiding the CEO and senior management. However, worldwide they are lambasted for catering to the manifested interest of CEO and senior management at the expense of shareholder interest. The criticism is that boards’ failure to maintain independence results in  under-performance.

A prime example is the decision of Satyam board to acquire Matyas. The board approved a deal of USD 1.6 billion to acquire Maytas Infra for USD 300 million and Maytas Properties for USD 1.3 billion. Ramilanga Raju after admitting the Satyam fraud stated that deal was to fill Satyam with real assets instead of fictitious assets. The scandal came out as shareholders refused to approve the deal and Raju didn’t have a way to cover the fraud. The recent case of  Kingfisher Airlines debacle clearly shows that the board was not asking the right questions.

Mr. N. R. Narayan Murthy, founder of Infosys, in his book “A Better India, a Better World” succinctly describes the prevailing trends. He wrote – “A a result, the 1990s was the era of the stock-option-fattened, superman-superwoman CEOs who could do no wrong in the eyes of their admiration-heavy boards, and who were seen as demigods. Lax oversight by the boards made these CEOS more or less omnipotent.” He has lead corporate governance in India by walking the talk and his scathing comments are right on target. He has given a number of suggestions to improve corporate governance and board performance.

Let us see, whether Indian boards are up to the task. To analyse the performance of the boards, I have taken the best practices of the board from the report of Trinity Group and Mr. Narayan Murthy’s book. The statistics are from  India Board Governance report 2011 and the relevant laws are from the New Companies Bill 2011.

1. Constitution of the board

Corporate governance practices mention ideal board size of 8-12 members with around one-third to half the members being non-executive and independent directors.  Indian boards on an average had 9.6 directors of which 5.2 were independent directors in 2010 and 60% of the boards have separate roles for CEO and Chairpersons. On the whole, this sounds good, however, in light of the additional information given below, the perspective changes.

a)    In 2010 in India, board chairpersons were members of 9.5 external boards though majority of the memberships were of private companies. According to the survey “the maximum public board memberships held by an individual was 12, and the maximum private board memberships a whopping 37″.

b)   The CEOs & managing directors were on an average board members of 7 external boards. “The highest number of public company board memberships held by a CEO was 10, whereas it was 32 for private company boards.”

c) Non-executive directors, on an average held a total of 6.7 total board memberships, with 2.1 public and 4.6 private memberships.

d) 56% of the directors surveyed identified the limited talent pool as an impediment, with 38% perceiving it as a major hindrance. Yet, less than 10% used search firms or other 3rd party sources to locate suitable talent.


The lack of experienced and trained directors is the key reason for a few directors available in the talent pool holding multiple memberships. When most independent directors are selected from the social circle of the CEO or Chairperson, there are very few who would not toe the line stated by the CEO. With the multiple holdings, a conflict in one board may impact the relationship in another board. Hence, instead of independence, diplomacy and self-interest prevails.

Mr. Murthy candidly mentions that “board independence from management continues to be affected by directors who have limited accountability to shareholders and are ill-equipped in exercising management oversight.” He stated that in Infosys, directors are given training and a job charter to ensure that they fulfill there responsibilities appropriately.

2) Strategy review by the board

According to the best practices given in the Trinity report, “the board’s primary responsibilities include : (a) reaching agreement on a strategy and risk appetite with management, (b) choosing a CEO capable of  executing the strategy, (c) ensuring a high-quality leadership team is in place, (d) obtaining reasonable assurance of compliance with regulatory, legal, and ethical rules and guidelines and that appropriate and necessary risk control processes are in place, (e) ensuring all stakeholder interests are appropriately represented and considered, and (f) providing advice and support to management based on experience, expertise, and relationships.”

On the other hand, the Companies Bill mentions the board’s power as: “ (a) to make calls on shareholders in respect of money unpaid on their shares; (b) to authorise buy-back of securities under section 68; (c) to issue securities, including debentures, whether in or outside India; (d) to borrow monies; (e) to invest the funds of the company; (f) to grant loans or give guarantee or provide security in respect of loans; (g) to approve financial statement and the Board’s report; (h) to diversify the business of the company; (i) to approve amalgamation, merger or reconstruction; (j) to take over a company or acquire a controlling or substantial stake in another company; (k) any other matter which may be prescribed

The theoretical legal powers given are quite different from the actual working of an effective board. On an average in India in 2010, board members met 6.5 times during the year. The minimum number of meetings were four, that is a statutory requirement and maximum were 19 board meetings by a company. The boards met on an average three times during the year for strategic and business review.

Considering the number of meetings conducted by the board, with the legal responsibilities and practical requirements, it is not feasible for the boards to do a constructive strategic review of the business or provide regulatory oversight. Too big a mandate has been given, while the time spent on it is relatively small. It is not surprising that most boards are acting as rubber stamps to the senior management plans. It is a case of imbalance between power, responsibility and time commitment.

3. Focus on risks

After the Satyam scandal and financial crises, the board focus on risk management has increased. The boards ideally need to determine the risk appetite, review internal audit reports and external auditors reports, understand various strategic, financial and operational risks, and maintain compliance oversight.  In India, the Company Bill mandates an audit committee for listed companies, with majority being financially literate independent directors.

In 2010, in India, 69% of the board members respondents stated that boards are considering risks as top priority. However, 31% mentioned that boards are not involved in systematically addressing corporate risk management.

My view is that the focus on Indian boards is more on risk of misreporting financial statements rather than others. Risk management field as such is still in young stage in India, and board members are ill-geared or untrained on the various aspects.

4. Information availability

The decision-making of the board is subject to the information available with it. As per law, board members are ideally required to receive all relevant information about board resolutions and decisions, seven days before the meeting. However, board members responded that most of the documents are given prior to the meeting or just a couple of days in advance.

Moreover, “a vast majority of boards depend largely on management reports (90%) and informal management discussions (79%) for business information. Third party reports and stakeholder views are used as tools only by 23% of the companies.”

With such limited information, and high dependability on company sources, the directors may not be in a position to make informed decisions. The directors don’t even have sufficient time to study the presented information to make independent decisions and cross question the senior managers. Hence, this could be a key reason for poor performance.

5. Performance Review of CEO & senior management

The compensation committees recommend the CEO and other senior managers. In India, around 80% the respondent companies had a compensation or remuneration committee. The issue of CEO compensation isn’t as big as the western world, however, it is fast gaining prominence. Some high earning CEOs in the top 100 list are being evaluated on the basis of returns to investors.

The board as such has to evaluate  CEOs performance. In the west, the “star” CEOs are in the limelight and are paid high salaries in relationship long-term company performance. However, India scenario is different. Most of the critical positions in family organizations are held by family members and relatives. In such a scenario, the board or compensation committee are hardly in a position to evaluate the performance or recommend salary.

6. Performance review of board

As per law, the nomination committee reviews directors performance , and recommends removal. However, two-thirds of the independent directors stated the roles and responsibilities of non-executive directors are not defined clearly. Hence, without the clarity in role, the evaluations can hardly be constructive.

As such, the boards in India have the following three priorities: “ensuring overall corporate and statutory compliance (90%), monitoring business and operating performance (87%), and establishing and monitoring financial standards and internal controls (82%). Leadership development, succession planning, CSR and risk management continue to be low on the board priority list.”

The professionally run organization do claim for independent evaluation. For instance, Tata  and Infosys succession, the nomination committees were said to be doing independent evaluation. However, in both cases, questions were raised on the final selection. Though Mr. Murthy in his book mentioned that – “At Infosys, the chairman of the board sits with each board member, discusses his/her evaluation, and suggests remedies and course-corrections. The chairman’s performance review is handled by the lead independent director.

In my opinion, the practice of evaluating board performance only exists in some companies in India.

Closing thoughts

Unless the mindset changes to compassionate capitalism where business is done with integrity, decency and in a principled manner, boards will continue to be tutorial heads without much power and say. To ensure boards perform better, shareholders and investors need to become more active. The regulators need to ensure governance codes are followed in spirit and not just tick box mentality. A more elaborate role can be defined by regulators with mandatory requirement of time commitment and reporting requirements.

References: