IFRS Training Seminar

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					       The Changing Role of the Audit
      Committee: Applying the Lessons
                       Presented by
                Andrea St. Rose & Associates

                Bay Gardens Hotel – July 17, 2009




July 17, 2009    Andrea St. Rose & Associates
                 The Changing Role of the Audit
                Committee: Applying the Lessons
                         Agenda

   1. Global Overview of the Financial Crisis


   2. Current Issues and Risks – What Regional Audit
   Committees Should Know

   3. Setting the Agenda for future Success in the
          Caribbean

   4. Restructuring the Corporate Framework to
   Strengthen the Audit Committee

July 17, 2009
                 The Changing Role of the Audit
                Committee: Applying the Lessons
                         Agenda

   5. Implementing Audit Committee Fundamentals &
   Best Practice

   6. Question and Answers




July 17, 2009
                Global Overview of the Financial
                            Crisis




July 17, 2009
                Global over view of the Crisis

                       Structure


   1.The Making of a Financial Crisis

   2. The Global Experience

   3. Our Caribbean Experience – Jamaica, Trinidad, Antigua




July 17, 2009
                The Making of a Financial Crisis


Generally preceded by asset price bubbles and
 economic booms.

In many instances there are regulatory lapses.

Usually accompanied by Greed.

Corporate governance is usually weak

Risk Management Policies are usually weak or
 absent.
July 17, 2009
                The Making of a Financial Crisis


What we know for sure:

 Economies experience both upswings and downturns.

 During upswings companies tend to believe that the good times will
  never end.

 When profits are increasing – entities tend to turn a blind eye to the
  attendant risks.

 Above average returns tend to be accompanied by above average
  risk taking.

 We have learnt nothing from past experiences – e.g. The Great
  Depression of the 1930’s


July 17, 2009
                THE MAKING OF A FINANCIAL
                         CRISIS

If we know for sure that upswings are
 generally followed by downswings – then
 why is it that most companies are unable
 to weather the storm when it makes
 “landfall”?

We prepare for hurricanes but not for the
 financial tsunamis.


July 17, 2009
                The Making of a Financial Crisis

The Current Financial Crisis:
 The Sub prime fiasco:
        It is believed that the current financial crisis began brewing sometime
         during mid 2007.

        Prior to 2007, the US environment experienced high liquidity levels –

        With such high liquidity levels, financial institutions in the US, responded
         to a general Govt push encouraging home ownership.

        Financial institutions offered adjustable rate mortgage loans to
         individuals who were unable to comfortably afford the repayment of
         those loans.

        Those risky loans were pooled and sold as investments – repayment of
         which were secured by the cash flows from the underlying mortgages.


July 17, 2009
                The Making of a Financial Crisis

The Current Financial Crisis:
 The Sub prime fiasco:
        In the face of rising oil prices and higher cost of living,
         homeowners suffered cash flow problems.

        As persons gained an understanding of the financial
         environment, confidence levels began to fall – accompanied by
         a fall in demand for housing

        The sub prime mortgage owners found themselves in difficulty
         and were unable to make the monthly repayments – which
         sometimes increased due to interest rate adjustments - hence
         they defaulted.

        The underlying cash flows were no longer available to service
         the mortgage backed securities – the underlying securities
         became worthless.

July 17, 2009
                The Making of a Financial Crisis

The Current Financial Crisis:
 The Subprime fiasco:
        The result was increasing losses for those institutions that had
         invested in those securities, coupled with reduced liquidity.

        Stock prices began falling and equity holders suffered huge
         losses.

        Investors began loosing confidence in the Financial System –
         Asset prices were falling in values and investors wanted their
         monies back. Some institutions folded up while some with
         greater public interest were bailed out by Governments/Central
         Banks.

        As some institutions folded up employment rose and reached
         record levels in the USA.


July 17, 2009
                The Making of a Financial Crisis

The Current Financial Crisis:
 The Subprime fiasco:
        Given the global network overseas institutions that
         had invested heavily in those risky securities also
         suffered losses and so the dominos came falling
         down.




July 17, 2009
                The Making of a Financial Crisis

There were some “Smart” ones … or so it seemed.
The Collateralised Debt Obligations:

        Some smart people recognising the risks involved considered
         that the boom could not survive for long and took insurance to
         cover the possibility of default – akin to betting that the entity
         would fail.

        When the entities defaulted, the security holders demanded
         payment from the insurance companies.

        Given the extent of the defaults, the insurance companies came
         under pressure and some like AIG had to be bailed out by the
         US Govt.
July 17, 2009
                   THE GLOBAL EXPERIENCE




                            CASE STUDIES –
                A look at some failed institutions




July 17, 2009
                     Merrill Lynch & Co.

In 2005 CEO of Merrill Lynch pointed out:

“We’ve got the right people in place as
 well as good risk management and
 control.”
             E. Stanley O’Neal, CEO, 2005


Source on Merrill Lynch & Co.: G. Morgenson, New York Times, November
9, 2008.
Prepared by: Timur Gok
July 17, 2009
                         The Global Experience

Merrill Lynch & Co.
In 2007 and the first two quarters of 2008, Merrill
 had lost about a quarter of the profits it had
 made in its 36 years as a listed company (after-
 tax losses of $14b and $52b of write-downs).
                 Financial Times, August 28, 2008



Prepared by: Timur Gok




July 17, 2009
                         Merrill Lynch & Co.

Ahmass L. Fakahany was vice chairman
 and chief administrative officer
He was responsible for the firm’s market
 and credit risk management as well as
 corporate governance and internal
 controls
“Weakened Merrill’s risk management unit
 by removing longstanding employees who
 “walked the floor” talking with traders”.
Prepared by: Timur Gok


July 17, 2009
                         Merrill Lynch & Co.

Another key figure was Osman Semerci,
 who ran Merrill’s bond unit
Former employees described him as an
 “intimidating” manager “who would
 chastise traders and other money makers
 who told risk management officials what
 they were doing”
“There was no dissent. So information
 never really traveled.”
Prepared by: Timur Gok



July 17, 2009
                         Merrill Lynch & Co.

“The risk in Merrill’s business model
 became viral after AIG stopped insuring
 the highest quality portions of the firm’s
 CDO’s against default”




Prepared by: Timur Gok




July 17, 2009
                   Merrill Lynch & Co.




Source: Wall Street Journal (April 18, 2008).

                                                20
                         The Global Experience

In 2007 Citigroup CEO indicated:
Citigroup

“When the music stops, in terms of
 liquidity, things will be complicated. But as
 long as the music is playing, you’ve got to
 get up and dance. We’re still dancing.”
       Chuck Prince, Former CEO, Citigroup
                 Financial Times, July 9, 2007
Prepared by: Timur Gok


July 17, 2009
                         Lehman Brothers

Madelyn Antoncic, managing director of
 Lehman’s management committee and the
 firm’s chief risk officer, was sidelined
 because of her unease with the huge bets
 the bank was taking
“There was risk management, but the
 prevailing atmosphere was for fast growth
 and special fast-track treatment for what
 we now know were toxic deals.”
Prepared by: Timur Gok



July 17, 2009
                                     UBS

“Used to Be Smart”
The shareholder report gave three broad
 reasons for what went wrong:
        “The investment-banking arm's preoccupation
         with growth;
        “Reliance of the control team on flawed
         measures of risk.
        The culture of the bank.”
Source: The Economist, April 24, 2008.
Prepared by: Timur Gok
July 17, 2009
                         HBOS

HBOS dismissed Paul Moore, head of
 group regulatory risk between 2002 and
 2005, for raising concerns about risks
“They were not inclined to listen to a
 different view… I was one person
 speaking out with experience who did see,
 in a generic sense, the writing on the wall.”


Prepared by: Timur Gok




July 17, 2009
                The Decision Making Process




July 17, 2009
                         The Global Experience


Shocked!!!!!
"Those of us who have looked to the self-
 interest of lending institutions to protect
 shareholders' equity, myself especially,
 are in a state of shocked disbelief.“
                               Alan Greenspan

Prepared by: Timur Gok


July 17, 2009
                         The Global Experience

Lahde Capital ( USA)

In October 2008, Andrew Lahde, founder of
 California’s Lahde Capital, a hedge fund, quit
 the business. One of his funds had made a
 return 870 percent last year.
In his farewell letter, he attacked the “idiots”
 running the banks who were willing to take the
 other side of his bets.

Prepared by: Timur Gok




July 17, 2009
                                   A.I.G.

The bail-out of AIG cost US taxpayers
 $182.5 billion so far
Between 1968 and 2005, Maurice “Hank”
 Greenberg had been the CEO of AIG
“A bullying, omnipotent ruler—[a boss]
 who did not so much build a company as
 tailor it to his character and render it
 incapable of being run by anyone else.”
Source on AIG and AIG FP: M. Lewis, Vanity Fair, August 2009.
Prepared by: Timur Gok

July 17, 2009
                         A.I.G. Financial Products

Founded in 1987
“By 2001, was generating $300 million a
 year, or 15 percent of AIG’s profits.”
AIG FP employees kept 30 to 35 percent
 of the profits that they generated (the
 typical hedge fund keeps 20 percent)


Prepared by: Timur Gok




July 17, 2009
                         A.I.G. Financial Products

In 2001, Hank Greenberg—and the AIG
 board—appointed Joe Cassano as the
 company’s third CEO
Presumably, Greenberg “saw in him a
 pale imitation of his tyrannical self and felt
 he could control him”


Prepared by: Timur Gok




July 17, 2009
                         A.I.G. Financial Products

Under Cassano’s leadership, “AIG FP
 became a dictatorship”
“The way you dealt with Joe was to start
 everything by saying, ‘You’re right, Joe’.”
“Valued loyalty and obedience above all”.




Prepared by: Timur Gok



July 17, 2009
                         A.I.G. Financial Products

No one questioned it when AIG FP was insuring
 billions of dollars worth of subprime mortgages
Not only that, but along the line, Cassano had
 agreed to triggers that required the firm to post
 collateral if it were to lose its AAA credit rating
The company unraveled when the housing
 bubble burst


Prepared by: Timur Gok




July 17, 2009
                OUR CARIBBEAN EXPERIENCE




A Look at what has happened – The
 Caribbean




July 17, 2009
                OUR CARIBBEAN EXPERIENCE



Jamaican Financial Crisis ( late 1990’s)

Trinidad – Clico Financial

Antigua - Stanford International/ Bank of
 Antigua


July 17, 2009
                Jamaican Financial Crisis

Followed the bust of an asset price
 bubble.
There existed a relatively high interest rate
 environment.
Significant increase in non performing
 loans when property prices fell.
Dominated by a high level of related party
 transactions.
Legislative environment was relatively
 laxed.
July 17, 2009
                Jamaican Financial Crisis

The first Group to come under pressure
 was the Caldon Finance Group.
The result was contagion and a run on
 other financial institutions
The Government stepped in and formed
 Finsac to manage the sale of toxic assets.
The situation was brought under control
 relatively quickly.

July 17, 2009
                CL Financial Group

The group controlled assets in at least 28
 companies located in the region and throughout
 the world.

Its insurance arm are the main insurance
 companies in the Eastern Caribbean – Clico and
 British American Insurance Company.

In 2004 it was alleged that the Group had
 entered into certain high risk ventures

July 17, 2009
                CL Financial Group

Concern was raised by investors in
 respect of the impact of falling real estate
 prices and a decline in the price of
 methanol on the Groups overall financial
 situation.

In early 2009 CIB faced liquidity
 challenges and a subsequent run on the
 Bank.

July 17, 2009
                CL Financial Group

The Financial difficulties had to do with:
Excessive related party transactions which
 carry significant contagion risks.
An aggressive high interest rate resource
 mobilisation strategy to finance an equally
 high risk investment – much of which were
 illiquid – in T’dad and abroad.
Very high leveraging of the Group’s assets
 which constrained the potential amount of
 cash that could be raised from asset sales.
July 17, 2009
                CL Financial

The Central Bank later announced that the
 Min of Finance took over control of the
 assets and liabilities of CLICO, CIB and
 CMMB.




July 17, 2009
                BANK OF ANTIGUA/STANDFORD
                         INT’L BANK
 In 2009 it is alleged that certain companies of the Stanford Group
  were involved in a Ponzi scheme.

 This was apparently triggered by a review into the high interest rate
  policy of certain companies in the Group following the Madoff
  investigation.

 One Caribbean interest , SIB, an offshore Bank, was specially
  named.

 The result was a loss of confidence and a subsequent run on Bank
  of Antigua Ltd, a related company.

 The Central Bank stepped in and took temporary control of Bank of
  Antigua.



July 17, 2009
                Current Issues & Risks
                     What Regional Audit
                    Committees Should Know




July 17, 2009
                Current Issues and Risk

                      Structure

   1.A breakdown of Risk controls vs. Financial
   Reporting Controls

   2. What we already know

   3. Role of Audit Committee in Risk Management




July 17, 2009
                Current Issues & Risks

 Risk Controls Vs Financial Reporting Controls
 The current Global Financial crisis is not about “cooking
  the books” or not consolidating risky SPVs.

 It is about companies pursuing risky strategic activities –
  Boards and Senior management.

 Unlike controls over financial reporting which has been
  legislated ( Sarbanes Oxley Act), excess risk taking i.e.
  greed has not been legislated. (Compliance with SOX
  could not stop the current crisis)



July 17, 2009
                Current Issues & Risks

What do we already know:

 The Audit Committee plays a major role in the
  oversight of Risk Management.

 Internal auditors are required to evaluate and
  make recommendations for improving risk
  management processes.

 The toxic Mortgage Backed Securities were
  purchased by sophisticated institutional
  investors.

July 17, 2009
                   Current Issues & Risks

Role of the Audit Committee in Risk Management

      To provide effective oversight members of the audit
       committee are to have an in depth knowledge about
       the business, the major risks that it faces and the
       control environment within which the organisation
       operates.

      This means that Audit Committee should obtain some
       level of training with respect to Risk Management –
       otherwise they may not be in a position to effectively
       dispense their oversight obligations.




July 17, 2009
                       Current Issues & Risks

Role of the Audit Committee in Risk Management
 The case studies on the failed institutions pointed to
    lapses in risk management.
 As an audit committee member can you confirm the
    following:?
           The overall risk management strategy of the organisation has
            been well articulated.

           You fully understand the business and its exposures to
            significant risks.

           You have a good understanding of the products offered and
            the level of risks attached to same.

           A risk management culture is instilled throughout the
            organisation.

July 17, 2009
                   Current Issues & Risks

Role of the Audit Committee in Risk
   Management

           Number of audit committee members
            present.

           Number of internal auditors present

           No of persons who have received training in
            Business Risk and Controls / Risk
            Management.
July 17, 2009
                Setting the Agenda for future
                 success in the Caribbean
                      Emphasis on controlling
                          risk exposures




July 17, 2009
                Setting the Agenda for future
                success in the Caribbean
         In Setting the agenda for future success it is
          critical that risk issues are prioritize – the
          keys risks should be a top agenda item.

         An understanding of risks should focus not
          only on the downside risks but also on the
          upside risks.

         Focusing on the downward risks while
          ignoring upside risks results in the erosion
          of shareholder value.


July 17, 2009
                   Setting the Agenda for future
                   success in the Caribbean
                Six Key Recommendations for effective
                            Risk Oversight

         Full responsibility for risk oversight should
          be clarified, structured and reflected in
          charters.

         The Board should be well prepared for
          assuming its risk oversight role by
          undergoing training in risk management
          and providing analysis of the organisation
          risk profile.

July 17, 2009
                    Setting the Agenda for future
                    success in the Caribbean
                Six Key Recommendations for effective Risk Oversight

          There should be appropriate oversight of management's
           assessment of risk, the controls in place to mitigate risks and
           the monitoring of risk.

          The Reporting framework should include company level risk
           reports in conjunction with Board Papers.

          A process should be in place to assess and monitor risk
           management performance including such issues as the
           effectiveness of committee structures and charters; the level
           of the boards understanding of risk policies and the level of
           productivity of management and board communications.

          There should be direct board level with managers most
           acquainted with the organisation’s key risk.
          (Source: The IIA : A Holistic View of Risk
July 17, 2009
                Restructuring the Corporate
                        Framework
                     Strengthening of the
                        Audit Committee




July 17, 2009
                Restructuring the Corporate
                        Framework
                      Structure


   1.Corporate Governance – an overview

   2. The Dual Role of Boards

   3. Cases – Excessive Compensation




July 17, 2009
                Restructuring the Corporate Framework




         It all come down to Proper Corporate Governance




July 17, 2009
                         Corporate Governance

The set of rules that shape and constrain
 how effectively corporate managers
 deliver on their promises to investors in
 general and shareholders in particular.
Corporate governance rules may be
 explicit or implicit – they may be defined
 by laws and regulations, contracts, and
 social norms.

Prepared by: Timur Gok


July 17, 2009
                         Norms

Shareholder wealth maximization is a
 norm in the US and the UK, but not in the
 civil law countries such as France,
 Germany and Japan




Prepared by: Timur Gok



July 17, 2009
                     Comparative Norms

A corporation belongs to:
Its shareholders: US (76 percent), UK (71
  percent)
All of the stakeholders: Germany (82.7
  percent), France (78 percent), Japan (97
  percent)


 Source: Allen and Gale (CFS). Quoted in Macey (2008).
 Prepared by: Timur Gok
July 17, 2009
                         Promise and Premise

Promise
In the U.S., the fundamental promise is to
  enhance the value of the firm.
Premise
The financial crisis is partly the outcome of
  failed governance mechanisms that led to
  the violation of that fundamental promise.

Prepared by: Timur Gok




July 17, 2009
                         Challenge

In the shareholder-centric system,
 separation of ownership and control may
 lead to the violation of the fundamental
 promise
The “agency problem”




Prepared by: Timur Gok




July 17, 2009
                         Eloquent

“The directors of [joint-stock] companies,
 however, being the managers rather of
 other people's money than of their own, it
 cannot well be expected that they should
 watch over it with the same anxious
 vigilance with which the partners in a
 private copartnery frequently watch over
 their own.”
        Adam Smith, The Wealth of Nations

Prepared by: Timur Gok


July 17, 2009
                   Solving the Agency Problem

At least in the U.S., much of the burden of
 solving the agency problem was placed on
 incentives and compensation schemes.
         Ever-increasing pay to “align” managers’ and
          shareholders’ interests




Prepared by: Timur Gok




July 17, 2009
                Law of Unintended Consequences

Target
“Align” managers’ and shareholders’
 interests
Tool
Incentive compensation
Outcome
Distorted incentives

Prepared by: Timur Gok


July 17, 2009
                         Merrill Lynch & Co.

In 2007 and the first two quarters of 2008,
 Merrill had lost about a quarter of the
 profits it had made in its 36 years as a
 listed company (after-tax losses of $14b
 and $52b of write-downs).
             Financial Times, August 28, 2008
Merrill Lynch & Co. CEO Stanley O'Neal
 was paid $172 million from 2003 to 2007.

Prepared by: Timur Gok




July 17, 2009
                                  Others

Executives of seven troubled companies
 received almost $500 million in
 performance pay since 2005
        American International Group, Bear Stearns,
         Citigroup, Countrywide Financial, Lehman
         Brothers, Merrill Lynch and Washington
         Mutual.


G. Morgenson, “After Losses, a Move to Reclaim Executives’ Pay,”
New York Times, February 22, 2009.
Prepared by: Timur Gok
July 17, 2009
                         Idiots?

Stan O’Neal left Merrill Lynch with a
 package (stock options, unvested shares,
 deferred compensation, pension payments
 and other benefits) worth about $160m
Bear Stearns Cos.'s James “Jimmy”
 Cayne made $161 million before the
 company collapsed and was sold to
 JPMorgan Chase & Co.

Prepared by: Timur Gok


July 17, 2009
                Role of Boards of Directors

Oversee and evaluate the business;
Select, compensate, and, where
 necessary, replace senior executives;
Review the firm’s financial objectives and
 its accounting.
                      American Law Institute
        Principles of Corporate Governance

J. Macey, “Corporate Governance,” Princeton University Press (2009).
Prepared by: Timur Gok
July 17, 2009
                Dual Role for Boards



                     Manage




                        Monitor




July 17, 2009
                            Irreconcilable

“No man should be allowed to be a judge
 in his own cause, because his interest
 would certainly bias his judgment, and, not
 improbably, corrupt his integrity. With
 equal, nay with greater reason, a body of
 men is unfit to be both judges and parties
 at the same time.”


James Madison in Federalist 10 as quoted by J. Macey (2008, p. 54).
Prepared by: Timur Gok
July 17, 2009
                         Remedies

Insiders v. independent directors
Supervisory board v. management board
Board committees




Prepared by: Timur Gok




July 17, 2009
                Problems Run Deeper


 Groupthink

 Independent Directors lose their “independence” as long
  as they collect directors fees from the organisation.

 If the are not paid fees – they value may not be great

 Independent Directors with limited knowledge of the
  business contribute little to its strategic direction.




July 17, 2009
                Restructuring the Corporate
                        Framework

What can be done?
There is a need for the Audit Committee to play
 a role in monitoring the nature and extent of
 incentive schemes that are offered to
 management.

There should open lines of communication
 between the Internal Audit Function and the Risk
 Management Function so as to ensure that
 evolving risks are understood and addressed.

July 17, 2009
                Restructuring the Corporate
                        Framework

 To assist in their oversight function of risk the
 Audit committee in particular should receive
 training in best practices for managing risk
 exposures.

The qualifications and experience of Board and
 Audit Committee Members should reflect the
 needs of the Organisation – There are few Risk
 Professional or financial analysts on many
 Boards.

July 17, 2009
                Implementing Audit Committee
                 Fundamentals & Best Practice
                      Implementation is key




July 17, 2009
                         BEST PRACTICE

    The Institute of Internal Auditors have provided some guidance with
    respect to best practice for Audit Committees in dispensing their
    oversight function – ( Regard Risks):

 The Audit Committee needs to know the extent to which
  management has established effective Risks Management systems.

 Be aware of and concur with the organisations risk appetite.


 Meet periodically with those responsible for risk identification,
  assessment and management throughout the organisation




July 17, 2009
                BEST PRACTICE

Discuss with management how risks,
 including fraud risks, are identified and
 how those risks are assessed in regard to
 likelihood and impact.

Understand internal auditing’s role and
 planned coverage, and meet periodically
 with the CAE to discuss the Risk
 Management process.

July 17, 2009
                 BEST PRACTICE

 Review financial reporting risks, weigh them
 against the organisations risk appetite and
 discuss with management how effective the
 controls in place are to mitigate those risks,

 All Audit Committee members should receive
   information needed so that effective evaluation
   of the risk management process can be made.
( Source The IIA)


July 17, 2009
                BEST PRACTICE

A structured process should be in place to
 review the performance of the Board, as
 well as the performance of Committees of
 the Board – in particular the performance
 of the Audit Committee of the Board.




July 17, 2009
                WHAT IT ALLCOMES DOWN TO

At the end of the day it all comes down to:


 Good   Old Corporate
    Governance and

Effective Risk Management.


July 17, 2009
                Closing Remarks




July 17, 2009

				
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