5/2/19

1

FRAUD & SCANDAL – ROLE OF CORPORATE GOVERNANCE Presented by: Lisa M. Thouin, CPA, CGMA, Managing Director & Raji Sathappan, CPA, MBA, CRCM, CAMS, Director, Mercadien’s Financial Institutions Services Group

The IIA Philadelphia Chapter2019 Spring Summit - May 3, 2019‘Elevating Performance - Taking a Leadership Role in Raising the Standards’

AGENDA

• What is Corporate Governance?

• Roles & Responsibilities

• Fraud

• Internal Controls

• Trends & Issues in Corporate Governance

• Best Practices

WHAT IS CORPORATE GOVERNANCE?

• System of rules, practices & processes by which a company is directed & controlled.

• Way in which companies are governed & to what purpose.

• Identifies who has power & accountability, who makes decisions.

• Enables management & board to deal more effectively with challenges of running a company.

• Ensures businesses have appropriate decision-making processes & controls in place so interests of all stakeholders are balanced.

5/2/19

2

BOARD OF DIRECTORS ROLE

• Implement an effective business ethics program• Understand fraud risks• Maintain oversight of fraud risk assessment• Monitor management fraud & control-related activities• Oversee internal controls established by management• Set appropriate tone at the top

MANAGEMENT ROLE

• Understand fraud & red flags

• Understand their roles in the internal control framework

• Read & understand policy & procedure manuals

• Participate as required in creating & designing a strong control environment

AUDIT COMMITTEE ROLE

• Oversee fraud risk management to minimize risk• Oversight of auditor’s work - internal & external• Understanding of how management develops internal interim financial

information

5/2/19

3

INTERNAL AUDITORS ROLE

• Review adequacy of identified risks • Provide assurance to Board that fraud

controls are sufficient for risks & functioning effectively

• Ensures weaknesses are detected in management operations

• Provides basis for correcting deficiencies that escaped first line of defense before these deficiencies become uncontrollable or are exposed to external auditors

INTERNAL AUDITING PRACTICES TO AID IN CORPORATE GOVERNANCE

• Internal auditors are charged with ensuring that corporate processes & associated controls are functioning as intended

• Can determine if a corporation’s process could be improved & save corporation money or become more efficient

IMPORTANCE OF IMPLEMENTING STRONG POLICIES & PROCEDURES

• Policies address pertinent issues to avoid problems within the company• Procedures define a sequence of steps to be followed in a consistent

manner• Utilizing both policies & procedures during

decision-making ensures consistency in business practices & decisions.

5/2/19

4

UBER BREACH CASE STUDY

• Hackers stole data from 57 million drivers & customers• Leadership knew about breach for more than a year &

failed to disclose the information• $100,000 was paid to the hackers to keep incident quiet• Under the leadership of co-founder & prior CEO Travis

Kalanick• Board neglected one of its primary functions & failed to

properly supervise Kalanick as CEO. Result is not surprising given that Kalanick is not only a director, but had authority to pick other directors & served in the capacity as CEO

WHAT IS FRAUD?

• Wrongful or criminal deception intended to result in financial or personal gain

• Occurs when someone gains something of value, usually money or property, from a victim by knowingly making a misrepresentation of a matter of fact

• Act or course of deception, an intentional concealment, omission, or perversion of truth, to (1) gain unlawful or unfair advantage, (2) induce another to part with some valuable item or surrender a legal right, or (3) inflict injury in some manner

FRAUD TRIANGLE

5/2/19

5

FRAUD TRIANGLE

Three factors which are present for fraud:1. Incentive/Pressure - Pressure, such as a financial need, is the motive for

committing the fraud. One common pressure is a gambling problem.

2. Rationalization - Person committing fraud frequently rationalizes the fraud. May include, “I’ll pay the money back”, “They will never miss the funds”, or “They don’t pay me enough.”

3. Opportunity - Person committing fraud sees an internal control weakness & believing no one will notice if funds are taken, begins fraud with a small amount of money. If no one notices, the amount usually grows larger.

HOW DOES FRAUD MANIFEST ITSELF IN A BUSINESS?

• Lack of transparency – complex financial transactions that are difficult to understand are an ideal method to hide fraud.

• Poor management information – where a company’s management information system does not produce results that are timely, accurate, sufficiently detailed & relevant

• Lack of clear moral direction from senior management – leadership comes from the top. Where the senior management indulge themselves in ‘semi-corrupt’ behavior

• Poor accounting controls – when the accounting controls, such as a monthly reconciliation of the bank account, lack signals that fraud has occurred.

WELLS FARGO CASE STUDY• 2011- 2015 employees were opening fake

customer accounts• Phony accounts earned the bank unwarranted

fees & allowed Wells Fargo employees to boost their sales figures & make more money

• Employees created phony PIN numbers & fake email addresses to enroll customers in online banking services

• Bank employees opened over 1.5 million deposit accounts, submitted applications for 565,443credit card accounts without their customers' knowledge or consent

• Roughly 14,000 of those accounts incurred over $400,000 in fees, including annual fees, interest charges & overdraft-protection fees

5/2/19

6

TONE AT THE TOP• Term used to define management’s leadership &

commitment towards openness, honesty, integrity & ethical behavior

• Most important component of the control environment

• Set by all levels of management & has a trickle-down effect on all employees. If the tone set by management upholds honesty, integrity & ethics, employees are more likely to uphold those same values

• Employees pay close attention to behaviors & actions of their bosses & follow their lead. In short, employees will do what they witness their supervisors doing

WHAT ROLE DOES CORPORATE GOVERNANCE PLAY IN FRAUD

PREVENTION & DETECTION?

• Effective corporate governance measures are essential to prevent corporate scandals, fraud & potential civil & criminal liability

• Describes principles, functions & essential components of a corporate governance system

• Addresses controversy of CEO duality, recommended committees any organization should have on its board of directors & how to set appropriate tone at the top

REGULATORY CHANGE & IMPACT TO BANKING-POST FINANCIAL CRISIS

• Lenders awash in new regulations, and growing armies of rule enforcers are forcing striking changes on banks’ internal cultures.

• Regulatory tightening has helped change the profile of banks in the post-crisis era. Now it looks more like a utility, subject to complex rules about how it can do business, and answering to government watchers.

• Most recently we have seen Facebook answerable to Congress on its failure to protect personal data. Regulatory oversight of social media giant is eminent.

5/2/19

7

STRONG CORPORATE GOVERNANCE NEEDED FOR MANAGING FRAUD RISK

• It’s important to maintain a proper corporate governance structure along with effective policies & procedures for fraud risk assessment, fraud prevention, detection & investigation

• If a company does not have a good understanding of risk, the likelihood of conformance & performance failure is high

WELLS FARGO CASE STUDYHOW MANAGEMENT PUSHED FOR FRAUDULENT ACTIVITY

TO TAKE PLACE WITHIN THE COMPANY

• 2010: Wells Fargo imposed extremely aggressive sales goals on its employees. oWere told to sell at least 8 accounts for every customer, compared with

an average of three accounts 10 years earlier - CNN

o Supervisors threatened salespeople who failed to meet goals - LA Timeso Former employee: “We were constantly told we would end up working

for McDonald’s… If we did not make the sales quotas … we had to stay for what felt like after-school detention, or report to a call session on Saturdays.” – The Huffington Post

IS IT A BURDEN TO BE A CORPORATE EXECUTIVE?

• U.S. is trying to avoid protecting corporate executives by putting more behind bars

• Determining criminal intent can be tough in large corporations, particularly with high profile executives, who may be insulated from day to day activity in which misconduct occurs

• No matter position held, any & all individuals should be accountable for their actions

• If criminal convictions aren’t on the rise, it is at least a subject that is being taken more seriously as there is a global conversation about the right way to approach corporate crime

5/2/19

8

4 RECENT CORPORATE EXECUTIVES ARRESTED FOR WHITE COLLAR CRIMES

• Yang Weidong - President of Alibaba’s Youku• Arrested in China for alleged acceptance of illegal

payments

• Oliver Schmidt - General Manager of Volkswagen• Pleaded guilty in 2017 to violating Clean Air Act in the

course of his company’s emissions fraud scandal

• Meng Wanzhou - Chief Financial Officer of Huawei• Arrested in Canada for alleged violations of U.S. sanctions

on Iran; has become linked to U.S. - China trade dispute• Carlos Ghosn - Chairman of Nissan

• Japanese authorities charged him with underreporting his income

IIA Position Paper - 3 LOD in Effective Risk Management and Control (January 2013)

BIRD’S EYE VIEW OF THE 3 LINES OF DEFENSE

INTERNAL CONTROLS

• Play a vital role in ensuring success of a business organization & preventing corporate fraud.

• Internal control activities that ensure proper corporate governance include:• Monitoring by board• Internal audits & robust policies• Proper balance of power

• Performance-based remuneration• Monitoring by large shareholders & other stakeholders

• Whistleblower testing

5/2/19

9

WELLS FARGO CASE STUDYHOW COULD INTERNAL CONTROLS HAVE MITIGATED WELLS FARGO’S

FRAUD RISK – INDEPENDENCE FOCUSED POLICIES?

• Bank’s goals were unrealistic meaning their business strategy became vulnerable to corruption

• Company as a whole could have benefitted from frequently reviewing their employees’ own goals to ensure they kept up with company’s mission

• Did risk management….• satisfy themselves that fraud risk assessment (assuming one was done) was complete?• monitor level or type of consumer queries & complaints, which should have been a

leading risk indicator?• have effective monitoring of customer satisfaction, which should have been a risk to

assess & watch?• do sufficient work relating to organization’s culture?

CONTINUED: QUESTIONS FOR THE INTERNAL AUDITOR

• Internal auditors could have been more skeptical.• Were any warning signals picked up by auditors in the course of

their work?

• Were they so focused on completing audit program that they were not watching & listening to what was happening around them?

• Were they ‘auditing by walking around’? Did they listen to employees or customers at all?

GLOBAL TRENDS IN CORPORATE GOVERNANCE

• In 2019, there should be an emergence or continued development of key global governance trends:

• Board quality & composition at the heart of corporate governance • Board diversity – age, race, gender

• Deeper focus on oversight of corporate culture.• Understanding shareholder motives – ST vs. LT

• Formulation of various committees• Internal financial controls & disclosures

5/2/19

10

EMERGING ISSUES IN CORPORATE GOVERNANCE

• Key issues which Boards will have to address themselves to:• Greater attention towards director

independence• Better boards & diversity• Risk governance & risk

management• Information technology

governance• Increased focus on strategy &

value creation

QUESTIONS?

CONTACT US

#SpringSummit2019IIA PHILADELPHIA CHAPTER 2019 SPRING SUMMIT

Lisa M. Thouin, CPA, CGMAManaging Directorlthouin@mercadien.com609-689-2329

Raji Sathappan, CPA, MBA, CRCM, CAMSDirector

rsathappan@mercadien.com609-689-2348

5/2/19

11

DISCLAIMER, TRADEMARK, AND COPYRIGHT NOTICEPHILADELPHIA CHAPTER OF THE IIA

• The Philadelphia Chapter was established in 1943, and is the 5th affiliate chapter of The Institute of Internal Auditors (IIA). The Philadelphia Chapter, its board of governors, its officers, The IIA , and today’s presenters are not responsible or liable for any acts or omissions and specifically disclaim any and all responsibility or liability for acts or omissions.

• The material contained herein or communicated is for informational purposes only and should not be construed as accounting, financial, tax, or legal advice. Please seek guidance specific to your questions or concerns from qualified advisors.

• All content including graphics or art work is protected by law and may not be duplicated in any form with out the express written permission from the Philadelphia Chapter.

• © 2015 Philadelphia Chapter of the IIA

IIA PHILADELPHIA CHAPTER 2019 SPRING SUMMIT #SpringSummit2019

Follow us on Social Media:

@IIA Philadelphia

Institute of Internal Auditors Philadelphia Chapter

hhtps://www.linkedingroups.com/groups/106938

Visit our FB page: IIA Philadelphia

IIA PHILADELPHIA CHAPTER 2019 SPRING SUMMIT #SpringSummit2019