Once the chairman relented and called the meeting, the source of his reluctance became clearer. Speaking to her by phone later that day, the chairman chided her: “Do you have any idea what I am about to do? I’m about to blow up this company.” There are few (if any) instances in which an internal audit has disclosed information as consequential as that in the WorldCom case. Yet it is certainly not the only time that an audit committee or its chairmen have elected to “stick their heads firmly in the sand,” rather than to hear damaging or uncomfortable information from internal audit.
In a recent conversation, the CAE of a highly respected company told me that his audit committee doesn’t appreciate the candor tries to bring to their meetings. He quoted his audit committee chair as cautioning him to “not come off like Chicken Little” in committee meetings. Other CAEs have conveyed their frustration that their audit committees hear bad news but do nothing about it.
I am also rarely surprised when CAEs cite examples of management’s reluctance to hear bad news — whether about their own operations or about the actions of colleagues or subordinates. The vast majority of executives are indeed willing to hear the truth, but there still are far too many — CEOs and chief financial officers included — who would rather not hear the bad news from internal audit. On rare occasions, they might prohibit internal audit from appropriate disclosure of results, or they might retaliate against CAEs who do. The “safety net” for those CAEs who work for nefarious executives should be the audit committee. After all, the board of directors and its audit committee have a fiduciary responsibility to look out for the shareholders — right?
What disappoints me more than the tales of obstructionist executives are the experiences of CAEs whose audit committees are reluctant to hear everything internal audit might have to share. Sometimes, the reluctance is guided by their desire to avoid bad news — as may have been the case at WorldCom or the other examples I cited above. Other times, it’s because their plate is overflowing and hearing even one more risk or control failure is just not desirable. Regardless of the motive, a disinterested or — worse yet — antagonistic audit committee is the last thing a CAE needs.
Based on my own experiences the first-hand experiences of CAEs, I have identified several examples of information or internal audit results that often make audit committees uncomfortable. These include:
It is rare that the chairman or full audit committee explicitly precludes the CAE from discussing those topics. Instead, an audit committee’s limited appetite for such feedback is more often masked. For example, if the audit committee never asks the CAE about any resource or scope limitations, it makes it much more difficult for the subjects to come up. An audit committee can also limit the potential for bad news by limiting or concurring with limitations on internal audit’s scope. For example, if the scope of internal audit’s coverage is limited to assessing the effectiveness of financial controls, the audit committee will likely hear very little about operational, technology, or compliance risks unless the assessment is coming from management. A CAE recently shared with me that, when he tries to share his perspectives on non-financial related risks, the audit committee gently reminds him that non-financial risks are outside internal audit’s scope.
My objective is not to impugn audit committees or their beleaguered members. The vast majority are very vigilant in executing their roles. But I believe any reluctance by audit committees to hear/solicit everything internal audit needs to say presents the profession with a call to action. We must do a better job of articulating the roles we can play in enhancing risk management and internal controls in our organizations. We should encourage audit committees to ask the tough questions — and when they don’t, we should volunteer the answers anyway.
While it is unlikely that any of us will ever have to threaten to call a meeting of the audit committee on our own, we should never shirk from our responsibilities to keep the audit committee fully and promptly informed, particularly about those things they might not want to hear.
I welcome your thoughts on this delicate topic.
Thank you, Richard Chambers, for this insightful blog. Internal Audit – when it matters – operates in the political zone. There are “moments of truth” in the professional life of an internal auditor. Internal auditors face dilemma, worth studying more in-depth, I believe.
In her book, Cynthia Cooper, the former Vice President of Internal Audit at WorldCom, makes clear “that the tone set at the top is critical to fostering an ethical environment in the workplace.” She summarizes: “The World-Com fraud, as well as other high-profile frauds, involved collusion by executives at the highest levels” (Coopers, 2008, 297). Further studies confirm that in the case of boundary violations, top management is usually involved (Wells 2007, 328): ”either the CEO or the CFO was involved in 83 percent of the cases“.
What can internal audit contribute? What should internal audit focus on? I recommend the internal audit profession to focus on Corporate Governance, possibly become a “Gardener of Governance”; you heard me saying that before, I believe 🙂 With the words of Huse (2007, 15): “Corporate governance is seen as the interactions between various internal and external actors and the board members in directing a firm for value creation“. I recommend the professional standard setter, the The Institute of Internal Auditors Inc., to help strengthening the contribution of internal auditors in that arena, and to focus on what truly matters, thereby acknowledging the limits of internal control systems.
CEOs and top management of forward-looking organizations are trying to turn the so-called “soft” success factors that are particularly important to them into “hard” competitive advantages. Healthy corporate culture and good corporate governance can become a competitive advantage. The more successful companies will increasingly seek to harmonize result orientation (EBIT, Net Income, Cash Flow), employee orientation, and orientation to values and goals. On that journey, externalities matter, environmental and societal aspects become part of the success formula. Internal Audit can support as a “trusted governance advisor.” My 2 cents.
Cooper, C. (2008), Extraordinary Circumstances, The Journey of a Corporate Whistleblower, John Wiley & Sons, Inc., Hoboken, New Jersey
Huse, M. (2007), Boards, Governance and Value Creation, The Human Side of Corporate Governance, Cambridge University Press, Cambridge
Wells, J. T. (2007), Corporate Fraud Handbook, Prevention and Detection, John Wiley & Sons, Inc., Hoboken, New Jersey