Economic Crisis –Auditors Evolving Role

IAA Charlotte March 17 2010

Michael P. Cangemi CPA, CISAFormer CAE - CEO Etienne Aigner & FEI

Advisory Board Member – FASB, COSO

Management, IT, Financial Governance 1 Cangemi Company, LLC

Business Career

Merrill Lynch/Blair&Co – High School&College Ernst & Young – CPA – Dir IT Audit Phelps Dodge – CAE – VP - CIO Professional work – IS Control Journal (87-

07) & Books - Managing the Audit (Wiley) BDO Seidman Ptr. IT Audit – IA Services CFO/COO to CEO Etienne Aigner, Inc. 91-04 CEO Financial Executives Intl 07-08 Advisory Boards – FASB; Pace Univ.; private

companies; Rutgers CA/CM – fmr COSO

Management, IT, Financial Governance 2 Cangemi Company, LLC

Leverage infused Credit Crisis

Lehman Brothers – wiped outBear, Merrill, Wachovia – merged200+ banks taken over by FDIC32-1 leverage – more on this risk laterAIG- regulated company – Gov take overGM- non -regulated – Gov take over" Greenspan said, "We are in the middle

of a once-in-a-century credit tsunami."

Today’s Goals:

Managements Prospective

1. Crisis – impact on your businessRecession puts pressure on costs – even

audit and recently IT spending; efficiencies from IT have been #1 cost reduction driver

2. What else auditors should be doing!

3. Fraud risk always present: rises in downturns – but always present!

Credit Crisis - Primer

Recent HistoryWhat caused this Credit CrisisEasy Monetary Policy

And A simple financial instrument

Sub-Prime Malfeasance

A mortgage was a safe loanSecuritizations -Packaged into Mortgage

Backed Bonds – Fee income for IBPackages of Mort-Backed Bonds into

Collateralized Debt Obligations (CDO)Good collateral – until no money down,

interest only, credit scores don’t matterHouse prices declined = crash!!!

Roots of a problem

Community Reinvestment Act

Born in the Carter Administration

Praised by Bush- Clinton- Bush

Ordered banks to extend loans to minorities; lead to more loans

Fannie & Freddie offered to securitize the loans – Congress expanding home ownership!!!

If not Bad Guys – Fee Income is gone

Management, IT, Financial Governance 8 Cangemi Company, LLC

Market Cycles 101

Blame game

Lax Credit criteria – system of moving risk to others – after taking fees

Unregulated mortgage brokersAdd 2% and 20% --- leverageLack of adequate regulation –CDO’sSoft regulation on Short sellingRating Agencies – big issues!!

Fair Value Accounting

Not the problem – always used LCM FASB-IASB issued guidance in reaction SEC reviewed Fair Value Accounting Jan 09 FASB issued guidance on valuations

157e Determine when a market is Not Active 115a Other than Temporary Impairment

BIGGER ISSUE is sovereignty and regulatory oversight of accounting under IFRS

Wall Street & Derivatives- CDOs

What are credit default swaps – insurance – maybe or bets – shorts and longs –weak regulation (Bucket Shops – Jesse Livermore)

New Regulations coming –BIG Changes

mandate oversight over the credit default swaps market & more regulation of short sales

New Regulations –

Federal reserve gains regulatory power over “too big to fail” institutions

Financial Services Oversight CouncilAddresses gaps in regulation

Consumer Financial Protection Agencynew rules over credit cards, mortgages and

other consumer products

Three selected Mega Trends

1. Sever recession – credit contraction

2. Globalization - Competition Rise of Elephant & Dragon; Brazil etc. Expansion of Global Capital Markets -

Global Shift: 2003 US was 44% - 2007 33%

3. Audit costs basically doubled – but recently rationalization of SOX costs

What is in our post crisis future?

A slow economy – recession or “Great”

Initially major impact from drop in capital markets - losses of 401K Market has come back – avoided crash

Management Perspective -much higher unemployment

Lower consumer spending – lower USA - GDP

New Playing Field

Eco Crisis leads to BIG changes –

GM Bond holders lose to employeesGov takes equity and management

decisionsFed - systemic risk regulator; SEC-PCAOB?New consumer regulator

What will be the “New Normal”

High levels of Government Debt

Very large Government – new regulations

Inflation – around the corner

Higher taxes & Savings= lower consumer spending –on goods and services

Continued difficult business environment

What are you changing?

Management, IT, Financial Governance 18 Cangemi Company, LLC

React to the New Normal

US will be less of an economic powerMaybe US $ replaced by a basketMore outsourcing – to lower cost

countries – accounting, audit & IT

Difficult Business environment – should lead to innovation – lots of changes

New Normal – Audit –IT Audit

Get in the flow with managementMy Book: Periodic Audit Mgt Change Innovate/Reinvent - Respond

Larger focus on formal ERM - GRCTo Do- Lower cost – higher imagination

COSO Continuous Audit & MonitoringDiscuss further greater coverage lower cost!

Outsourcing audit – Global

ERM -

Banks measure credit risks – programs based on underlying financial strength ratings and probabilities

In non-financial there are many different business risks – boards address on an ongoing basis; not as obvious

All subject to management override

Audit Involvement in ERM

Basically a good thing – to a degree BUT – What is ERM and note it works

until management overridesLeman; Merrill; Bear – had risk modelsTrying to apply Fin Company risk model

My advice:Set your Audit Charter realistically

Leverage – 1929 in a new form

32 to 1 – are you kidding!!

Say you raise $10,000,000Now investing $320,000,000 - OPMEarn 2% Fee = $6.4 M vs. $10 M raised

Did IA have a risk comment – ERM ??

Buffet’s comments in DC : 2% & 20% rule

COSO - ERM

page 3 -“ERM enables management to effective deal with uncertainty.”

Page 5 - Achievements of strategic objectives and operations, however, is subject to external events not always within the entity’s control

Page 13 - All entities face uncertainty the challenge is for management - how much uncertainty is it prepared to accept?

Question – how do you determine how much of an unknown you are prepared to accept.

IA Adding Value ROI Challenges

Not producing products or revenues!!How do you contribute more to the

business?Set IA Charter High – Improve control;

E&E of ops and positive deliverablesIA – People, Procedures – ReportsTake advantage of automation

IA Adding Value – ROI

Use of Technology – different solutions by sizes of company

Continue to expand use of automation for administration and audit testing

Use leverage – recommend built in CM controls testing to business units; help them implement

COSO Cube

Recognized as the major framework for evaluating internal control

Opportunity to build in controls; save money; increase coverage; find errors; recover $$$

New Normal for Audit - Monitoring - Make Audit efficient

A means to control efficiency and effectiveness.

“Management should be able to rely on self-assessment and, more generally, the monitoring component of internal control, provided the monitoring component is properly designed and operates effectively” (PCAOB, AS5, P. 5)

Concepts of Monitoring

New Generation – CM Software

ACL; IDEA; Approva & OversightOversight Systems

No business process works perfectly. The sooner an error is identified and corrected the better. Oversight's advanced analytics inspect each step in every transaction in a financial business process to identify fraud, misuse and error.-- Oversight Systems

New Normal - Oversight’s continuous auditing solution

built-in report and dashboard features that present continuous risk reports with color-coded risk ratings (i.e., red, yellow, and green) for all key control objectives.

threshold-oriented reports automatically alert audit professionals

Audit Dash boards

© 2007 Oversight Systems 33

Click-through to Relevant Exceptions

© 2007 Oversight Systems 34

Plain Language Exception Descriptions

New Normal -Lower Audit Costs

Costs - SOX caused audit cost to increase

Now is the time to rationalize, make the control structure more efficient

CCM is an answer to expanded ERM

EDPACS Article – case studies

Fraud – everyone now tuned in to possible fraud – thanks to Bernie et al – CCM – it will continue!!!

Financial Scandals & Markets

Financial Scandals are not a new phenomena

Management, IT, Financial Governance 36 Cangemi Company, LLC

Recent Financial Market Crises

1980s Saving & Loan Bailout1987 Market drop and rapid recovery1998 Long-Term Capital failure & fallout9-11-2001 – terrorist attacks2001-02 - accounting scandals and

bankruptcy's –some caused by bad guys2007-08 sub-prime induced dislocation-

some again caused by bad guys

Discovery of America – New Land Schemes

Management, IT, Financial Governance 38 Cangemi Company, LLC

Madness of Crowds

The Tulip Bulbs Bubble 1600’s – emotional market ??

South Seas & Mississippi Companies – UK investors bet on America

1800-1900 Rail Roads Bubble1990’s Internet Bubble 2000’s corporate frauds leads to SOX!

Management, IT, Financial Governance 39 Cangemi Company, LLC

Bad Guys circa 2009 - Global

Société Générale

– one trader $7.2 billion lossBernie Madoff – never bought a securityTexas financier R. Allen Stanford -sold

CDs in US kept the cash –Global Fraud!Venezuela "seized a failed bank controlled

by Stanford after a run on deposits” UBS Off Shore Accounts Investigation

Closing Thoughts

Audit is a business – must be efficientBusiness run on cash

Try for cash recoveriesLower expenses

Careful expanded focus on GRC- ERMBe creative – innovate – high imagination

low cost solutions – use automationThink Globally

Management, IT, Financial Governance 41 Cangemi Company, LLC

Questions?

Management, IT, Financial Governance 42 Cangemi Company, LLC

Cangemi Company LLC

Senior Advisor & Board MemberConsulting –Financial, Strategic &

Governance , Internal AuditMedia -speaking; teaching Book -Managing the Audit Function;

available at Amazon, Wiley and other book sellers

mpcangemi@msn.com

Management, IT, Financial Governance 43 Cangemi Company, LLC