PDF File: 

CFO2_wp_mcgarvie.pdf

Leadership for International Finance LLC

Editor’s Note: Blythe J. McGarvie, a member of the editorial review board for The CFO Project, recently spoke to a group of auditors.We’ve adapted the speech here because it touches on many of the concerns addressed in The CFO Project.

You are going to take a test, and everyone is going to participate.

Here’s the situation:You have just been hired by a company.You have three weeks to get out an earnings release.You have a meeting with your new CEO in one hour to tell him what you are going to do. You investigate and find out there is no balance sheet. You have four choices:

1. Do it. Release the earnings as expected;
2. Hurry up and put in lots of provisions just in case you discover some bad news in the future;
3. Delay the release and not talk with the Street for at least three months until you know all the facts behind the balance sheet; or
4. Blow the whistle. Go public with your discovery.

This was the same dilemma I faced in Paris in 1999. I thought I had my dream job: living in Paris,working for a well-known company, and indulging in the French cultural delights.

The only problem was that when I arrived in July 1999, the chairman expected me to release earnings in two weeks without having a balance sheet.To be accurate, that wasn’t the only problem, just the first one I discovered in my first couple of weeks. How did I get here and what was I going to do? How could the external auditors help with this situation? What did the board think about the financial results of the company? What was my responsibility to the outside investment community and to the board? Should I resign from my CFO position just weeks into the “dream job”?

To put the dilemma in perspective, one of my life-long dreams was to work and live in Europe.When I received the job offer, the chairman was quite good at building a credible story about the possibilities of growth for his company. He convincingly explained how he wanted his French-based company to be run with the discipline of the American financial world. When I did my due diligence, I reviewed some investment analyst reports and the most recent annual report from 1998. In France, companies are required to publish financial results twice per year, and many companies did not release quarterly figures except for net sales.

I was surprised that the 63-page report did not have more footnotes and explanations. In fact, how many financial pages do you suppose were in the annual report? Only 12 pages of financials were published, including the report of two independent auditors. But, I assumed that just like so many things in the French culture, the French accounting rules must be less strict than the U.S. accounting or International Accounting Standards (IAS) I knew. Plus,with two good auditing firms as the statutory auditors, certainly they knew what they were doing. So, I was in this position as a result of my inadequate due diligence and being somewhat blinded by the opportunity.

So what happened? I’m going to tell you how my personal story ends, because it speaks to the critical relationship between auditors, board members, and CFOs.

But first I want to talk about recent changes in the accounting profession, because today there is a new level of expectation. Let’s face it, outside auditors have suffered a bit in the press lately.To survive, you also must form a strong partnership with your CFO, CEO, and audit committee chairman.

I have been a CFO and I have been a board member.Now, I am a consultant helping people respond to the new rules and situation. I am going to talk to you about this new mandate from those three perspectives.

We have talked about what the CFO needs from you. He or she needs a strong partner:

• To provide a united position, and often with the best external perspective;
• To cooperate together to manage the company to a high standard for more independent board members and other corporate governance requirements; and
• To help attract great, qualified managers.

What does the board need from you? The same strong partnership and more.Audit committees must take their role to a new level of detail just to comply with the Sarbanes-Oxley Act and ensure procedures are in place as expected.

The first change in corporate governance the number of meetings. I read a survey from April 2003 indicating that the average number of audit committee meetings has increased from five to six since September 2002. The range of number of meetings from this survey moved from 1-to-14 as of September 2002 and up to 2-to-16 as of April 2003. Could you imagine holding only one audit committee meeting?

The second change is in the use of outside advisers.On one of my boards,we are analyzing auditor require pre-approval by the audit committee.On the boards I serve,we have established policies and procedures for specific classes of services or level of spending and a separate list of explicit non-audit services and activities requiring approval.

Finally, the tsunami that has yet to hit everyone is the requirement to respond to Sarbanes-Oxley sections 302 and 404.You are better experts on this than I am. But, clearly section 302, requiring the CEOs and CFOs to personally certify their responsibility for disclosure controls and procedures,will get attention at the highest level. Section 404’s mandate of an annual evaluation of internal controls and procedures for financial reporting and your independent auditor report attesting to management’s assertion on the effectiveness of these controls and procedures will require lots of work.As part of this process, the boards would like to see true value-added work from the auditors.This means not just tactical or operational suggestions, but responses to Sarbanes-Oxley should prompt strategic and organizational transformations.

As of May 29, the Securities and Exchange Commission delayed the effective date for Section 404 for a year. At Accenture,we do not have the same extension. As a result of an Aug. 31 year-end, Accenture will be one of the first to comply with Section 404 and will serve as a benchmark for the SEC and for other companies.

What Does the Consultant Do?

The consultant observes the scene and works with CEOs on this very topic: the defusing of time bombs and finding ways companies can avoid precarious situations, e.g, being under investigation from the SEC.

The world of corporate governance is evolving rapidly and becoming top-of-mind in the boardroom and at senior management. According to Financial Executive International, compliance with the new requirements from the Sarbanes-Oxley Act will cost Fortune 500 companies as much as $9 million initially and up to $8 million annually thereafter. This is not trivial.

Costs are always considered in hiring outside help and implementing new processes. However, costs matter little when an investigation was needed and none done. call this the trump card.What the auditors knew and when they knew it becomes paramount in situations that explode. As a board member, I rely on the auditor as the eyes and ears of what is happening and even what the spirit is deeper in the company. I am glad to learn about issues, as long as they are pursued to resolution and, if significant, are clearly and directly discussed with management and the board.

Charles Niemeier, the former chief accountant of the SEC’s enforcement division and now a member of the Public Company Accounting Oversight Board, stated, “Auditors knew what was happening but they were willing to look the other way” in some of the recent scandals. Such an attitude would keep me up at night. The board is not asking accounting firms to ferret out corporate fraud. However, what you do with the information you discover is the critical point. It now appears that in some of the biggest fraud cases, the auditing firms were tipped off or otherwise alerted to possible shenanigans but did not investigate deeply enough.

What is “deeply enough”? The best rule of thumb is to ask: If tomorrow The New York Times or The Wall Street Journal printed the query and response, assuming a fully vetted set of facts,would you be embarrassed or appear culpable? If yes, continue digging. One of the mantras that serves me well is to approach problem-solving with healthy skepticism.

I build on what I learned as a CFO and board member, tapping into the perspective of different industry and country practices to share with CEOs and other senior management with whom I meet.

As a consultant, I have learned that there are some suggestions that make a difference. Whatever your industry, there are ways to recognize time bombs and defuse them before they explode. The first rule: If things look too good to be true, they usually are not true.Make sure you can explain the risks and the business drivers in the income statement and, critically, the balance sheet and cash flow statement.

Second, if the adjustments to the monthly financials require manual intervention, it is a sign that more transparency or control is needed. Get documentation and enlist the support of the CEO and the audit committee, if necessary, by explaining the potential downsides to customary practice. Third, if management can’t explain why an item needs to be recognized as revenue and have the proof underlying it, it is time to do more digging to find the contract or meet with the vendor or analyze the estimates used.When in doubt, follow the cash.

Meanwhile, Back in France …

So how did my French adventure come out?

One month before I became CFO, the company had decided to select a new auditor. In some ways, I was disappointed to have not helped in the selection process, but as it turned out,we had no time to waste to make a difference. At the time, I felt I had a gun to my head or could choose to resign.Without the relationship I quickly developed with the external auditors, I was ready to resign and return to the United States, even before my dishes and personal effects had crossed the Atlantic.

I met alone with the chairman and told him that I could not sign off on earnings for the first six months without a meaningful balance sheet. I explained that Europe had not closed the first four months of the year until May. The balance sheet did not exist as it was significantly out of balance and had few accounting reconciliations to major reserves. I also met with the engagement partner from our auditor, discussed the situation, and both agreed to meet with the chairman and tell him it was impossible to release earnings by the end of July before the August vacations because there was no way to know accurately what they were.

The engagement partner obviously wanted to serve the client, but he also wanted to make certain that the right thing was done. Our united position convinced the chairman to delay the earnings release until the end of September and that we would need some staff to stay during the August holiday to create the necessary information. The strength of two was critical in a French company run by a strong chairman who controlled the majority share and was accustomed to getting what he wanted.

I believe, and have seen positive results time and time again, that a true partner relationship between CFO and audit partner is a critical success factor. I joke that only my minister and general counsel are closer to me in business. In fact, bringing transparency to and clarity of what the company is doing and explaining why to an outside, but confidential, source extends to the board members.

It is important, now more than ever, that the auditor, the CFO, and the audit committee chairman see each other as partners working together. Be direct, particularly if you are dealing with new information or rules. It is necessary to survive. Certainly, errors in judgment by one of these partners can create huge problems, even potential liabilities, for the others.