Compliance is about to get worse…

I think SharePoint is an excellent platform for quality improvement, PMO and compliance efforts. But this is a non SharePoint oriented post. I’m sick of writing nerdy stuff at the moment.

In 2001, the supposedly blue chip US multinational called Enron filed for bankruptcy. For you younglings who were still at school, this made pretty big news around the world. Many of the senior executives are still in jail for fraud related offenses. the whole sorry tale is one of greed, corruption, deceit, insider trading, huge theft of workers’ entitlements and massive job losses. As part of the collateral damage, Enron’s auditing firm, “Arthur Anderson” was also obliterated as its reputation dissolved quicker than Paris Hilton’s credibility.

google “enron scandal” – it’s interesting reading

Sarbanes-Oxley (real brief version)

Anyway, one of the things that came out of this and other scandals like Worldcom, was the Sarbanes-Oxley act. Its intent was to:

Protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the securities laws, and for other purposes.

It did this by creating new standards for corporate accountability, and significantly beefed up penalties for acts of wrongdoing. Boards and executives are now personally accountable for the accuracy of financial statements. There are additional financial reporting responsibilities, with particular focus on the verifiable application of internal controls and procedures designed to ensure the validity of their financial records.

Now executives tend to like spreading the love (risk) around, and if they are going to go down, they like to take others with them. So IT professionals also have to do their bit for the common good. This is because the financial reporting processes of organisations heavily utilise IT technology. As a result, IT controls that relate to financial risk are fair game.

So how to account for IT controls?

COBiT

COBiT is not the only IT control methodology used for SOX compliance, but it’s the only one I am familiar with 🙂 COBiT (Control Objectives of Information and Related Technology) is commonly used as the framework to cover all your IT controls. I won’t get into detail here, as COBiT is a big subject in itself, and I have some information here already.

SOX Criticisms

Was SOX an over-reaction to isolated indecent’s of large scale fraud? It is clear that some believe this to be the case. “Compliance cost is too onerous” is very commonly cited, particularly with smaller affected firms. Most scarily for me, is seeing the term ‘SOX’ being used as a sales tool for products that at best, have little relevance to what SOX compliance is really about. The same criticism can be levelled against service companies as well, who are happy to bag Microsoft’s amateurish use of FUD, yet use disturbingly similar methods to sell products and services that have questionable relevance.

When researching my training material last year, I came across this nugget of information that gave an indication of the level of frustration that SOX has caused.

A global study from European accountants Mazars, found that close to 20% of EU companies are planning to de-list from the US market to avoid complying and more than half feel the costs outweigh the benefits 

But I then found this interesting snippet.

However this has the potential to impact on the cost of credit for such companies as warned in July 2006 by Moodys. “The cost of capital for public companies in countries that choose not to implement US Sarbanes-Oxley (SOX) type corporate governance rules may soon increase to reflect the additional risk premium resulting from companies and their auditors concealing the true level of audit risk” 

So now we come to the point of this post. What did they say above? “Cost of credit”? So Moodys implies that SOX compliance offers a level of assurance to suppliers of capital.

Six Years Later

I liked Moodys’ quote in the previous section. Fast forward to the present and the word “credit crunch” is on the news quite a lot. So is it fair to rate the effectiveness of SOX compliance based on the current turmoil in financial markets?

To answer that question, we have to look at the current problems that have led to the current financial crisis affecting world markets.

Here is a pretty good layman’s summary that explains the sub-prime issue and the problems with stagnant or falling property values. However we need to delve a little deeper here. The New York Times has a great article that goes into the necessary detail but it is large, and I’ll try and paraphrase it as briefly as I can.

In the past decade, there has been an explosion in complex derivative instruments, such as collateralized debt obligations and credit default swaps, which were intended primarily to transfer risk.

These products are virtually hidden from investors, analysts and regulators, even though they have emerged as one of Wall Street’s most outsized profit engines. They don’t trade openly on public exchanges, and financial services firms disclose few details about them 

Among the topics they discussed were investment vehicles that allowed Citigroup and other banks to keep billions of dollars in potential liabilities off of their balance sheets — and away from the scrutiny of investors and analysts. 

Now what was the intent of SOX again? “To protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the securities laws, and for other purposes”. What do we see above? “potential liabilities off the balance sheet” … hmm

But there’s more..

Credit rating agencies, paid by banks to grade some of the new products, slapped high ratings on many of them, despite having only a loose familiarity with the quality of the assets behind these instruments.

Still others say the primary reason the Fed moved so quickly was to divert an even bigger crisis: a meltdown in an arcane yet huge market known as credit default swaps. Like C.D.O.’s, which few outside of Wall Street had ever heard about before last summer, the credit default swaps market is conducted entirely behind the scenes and is not regulated.

Ratings agencies have similarly been under fire ever since the credit crisis began to unfold, and new regulations may force them to distance themselves from the investment banks whose products they were paid to rate.

If you research into the fate of Arthur Anderson, they were screwed by a sudden and fatal loss of reputation as a result of their association and conflict of interest issues in relation to Enron. Disturbingly, the last quote above criticising ratings agencies reminds me very much of the conflict of interest criticisms levelled at audit firms like Arthur Anderson.

Crystal Ball Time

Since the practices quoted above are not necessarily illegal, and it is too early to determine whether the SOX laws will be used in a punitive sense to institutions caught up in the current crisis. I’m not a lawyer and as a result, my opinion here is naively uninformed. But like the Enron/Worldcom scandals, regulatory authorities and other interested parties will rightfully ask questions about risk management, and therefore the effectiveness of the controls for SOX compliant organisations.

This current crisis makes previous scandals pale into insignificance. A news site that I frequent reports that US investment bank Goldman Sachs  suggests that credit losses will amount to 1.2 trillion US dollars. That is a freakin’ *insane* amount of money and many people affected do not even realise it yet until they see their next pension/superannuation statement.

Consider that the world population is some 6.6 billion people. The above loss is therefore 180 US dollars per person on the planet! … Mind boggling isn’t it.

Notwithstanding the directly affected people who are defaulting on their mortgage, getting margin called, etc. Many, many people will be royally pissed. Politicians will react to this by forming committees to look at how to prevent this from happening again. SOX will be revised, or new regulations will be developed. More checks and balances, more compliance overheads, more disclosure.

Thus, more accountants, more lawyers, more business advisers, more IT security professionals, and of course, smelling a new FUD angle, more snake oil salesmen selling irrelevent products and services.

If companies think that their compliance costs are high now, just wait. I think it’s going to get a lot worse.