Fines Against Internal Auditors Raise Serious Questions

With greater scrutiny should come greater protections

Not much surprises me these days, but recent actions by an administrative law judge for the U.S. Office of the Comptroller of the Currency (OCC) are shocking. The judge recommended stiff penalties against three former Wells Fargo executives – the chief risk officer, the chief audit executive (CAE) and an internal audit director – over sales misconduct at the bank, according to a recent article in American Banker, a financial services trade publication. A combined $8.5 million in “civil money penalties” against the two internal audit executives is virtually unprecedented in my memory – particularly when examining the grounds upon which the fines were leveled.

According to the OCC Report and Recommendation, the former CAE is being slapped with a $7 million fine for:

Failing, as head of the bank’s third line of defense, “to timely identify the root cause of team member sales practices misconduct in the Community Bank, (failing) to provide credible challenge to Community Bank’s risk control managers, (failing) to timely evaluate the effectiveness of Community Bank’s risk management controls, and (failing) to timely identify, address, and escalate risk management control failures that threatened the safety, soundness, and reputation of Wells Fargo, N.A.”

The fine against the internal audit director is for:

Failing “to timely identify the root cause of team member sales practices misconduct in the Community Bank, (failing) to provide credible challenge when evaluating the effectiveness of Community Bank’s risk management controls, and (failing) to identify, address and escalate risk management control failures that threatened the safety, soundness and reputation of the bank.”

Lawyers for the three former Wells Fargo executives indicate plans to appeal the decision. “We are very disappointed by the decision but not surprised by it,” according to American Banker in quoting the attorney for the former CAE. “As we have said from the outset, (the former CAE) is being scapegoated, and he has yet to receive a fair hearing on the merits. We plan to challenge what we view as a deeply flawed decision and are confident of our prospects on appeal.”

I should note here that I am not an expert on the statutes and regulations that provided the basis for the OCC’s report and the administrative law judge’s opinion. Accordingly, I take no position on how the case was decided. It is also important to note that the penalties, even if upheld, do not automatically set a precedent that would apply to other internal auditors in the United States or anywhere else in the world.

But I do think there is language in the opinion that should serve as a call to action for the profession. The CAE and internal audit director are accused of not identifying root causes, not evaluating the effectiveness of management controls and not addressing and escalating risk management control failures.

If every internal audit executive and their staffs were put under the same microscope, how often could those same charges be assessed? Suffice to say, it would be a lot! The word “timely” also appeared three times in the specific allegations against the CAE and once against the director. Yet, how widely is timeliness emphasized by internal auditors? From my experience, we are far more focused on thoroughness and accuracy than timeliness.

The OCC report sets a bar for internal auditors in the U.S. financial services industry that many other internal audit functions here and around the world would not clear. That’s why I strongly urge CAEs to factor in these expectations when setting and reviewing their own quality assurance and improvement programs. Should the penalties in this case be upheld and eventually expanded beyond the financial services industry, the professional and personal risks for internal auditors will be too great to ignore.

There certainly is culpability on the part of those internal auditors who do not provide credible challenges, timely evaluate the effectiveness of internal controls or address and escalate risk management control failures. But there is an elephant in the room that cannot be ignored: In many companies, management and boards do not enable – or even permit – that kind of scrutiny. They simply do not want and will not tolerate an internal audit function that the OCC report seems to expect.

So, if government regulators and others intend to start fining internal auditors who do not fulfill their obligations or meet expectations, then safeguards and protections should be put in place for those who do! Internal auditors in many organizations find they are handcuffed when it comes to executing their roles free of restrictions and interference. I believe it is time for a conversation about greater statutory and regulatory protections for internal auditors.

For more than two decades, I have been a staunch advocate for limited government oversight and regulation of internal audit. I have argued that the long arm of government has no place in regulating how companies design and implement their systems of risk management and internal controls. However, if government begins to step in to call “balls and strikes” on how internal audit executes its role, then it should provide safeguards that will enable internal auditors to swing the bat when needed.

It may be time to expand whistleblower statutes to protect internal auditors who are subject to retaliation for doing their jobs. The “devil will be in the details” when it comes to how such statutes and regulations should be structured. But the time is fast approaching to have that debate.

I welcome your thoughts.