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Conflicts of Interest/Independence. For management and employees: Where the independent judgment of an employee is swayed, or might be swayed from making decisions in the organization’s best interest. Important Issues: Usual Causes : self-interest, misunderstanding Slippery slope

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conflicts of interest independence
Conflicts of Interest/Independence

For management and employees:

  • Where the independent judgment of an employee is swayed, or might be swayed from making decisions in the organization’s best interest.

Important Issues:

  • Usual Causes: self-interest, misunderstanding
  • Slippery slope
  • Inevitable...So how to manage to avoid harm
  • Appearance is vital
  • Guidance needed
types of conflict of interest
Types of Conflict of Interest

Potential Actual

Decision Point

Non-existent Apparent Imaginary

conflicts of interest causes
Conflicts of interest - Causes
  • How might judgement be swayed… any interest, influence, loyalty, concern, emotion, or other feature tending to make judgement less reliable than normal.D&S, 9.
  • Self-interest - bribes, kickback, gifts, free travel, favors, special advantages or treatment, dealings with family, relatives or relations
  • Fraud- misappropriation of funds or property
  • Misunderstanding - confused signals or incentives, boss/ everybody’s doing it, cultural differences, slippery slope
judgement based on common and conflicting interests
Judgement Based onCommon and Conflicting Interests

Judgements

Investors’ Interests

Congruent

Self-interested

Executives’

Interests

management of conflicts of interest
Management of Conflicts of Interest
  • Awareness and understanding- training
  • Guidance and compliance - code, signoff
  • Avoid - can’t always
  • Additional controls:
    • disclosure and consultation - ethics officer+
    • additional approvals
    • Chinese walls/Firewalls - confidentiality
    • prohibition and scrutiny
  • International aspects, www.transparency.de
gift or preferential treatment
Gift or Preferential Treatment

Guidelines for Acceptance/Giving:

  • Is it nominal or substantial?
  • What is the intended purpose?
  • What are the circumstances?
  • What is the position of sensitivity of the recipient?
  • What is the accepted practice?
  • What is the firm/company policy?
  • Is it legal?
conflicts of interest independence for professional accountants
Conflicts of Interest/Independence for Professional Accountants

Mandate relies upon:

  • Services that can be trusted by members of the public to serve their interests

Fiduciary Responsibilities

  • Fiduciary services
    • Reliance
    • Knowledge or skill differential
    • Important

Credibility

  • Trust, confidence, expectations
part of the livent affair drabinsky v kpmg
Part of the Livent Affair:Drabinsky v. KPMG

Livent – Phantom of the Opera, Showboat, restores theatres

On Nov. 29, 1999, Drabinsky (D) sues KPMG (KC) Canada for damages, costs and other relief for breach of contract, breach of duty of confidence, & breach of fiduciary duties

  • D alleges KC was his accountant … tax & bus. Advice …KC North Toronto (KCNT) Office says only personal tax
  • KPMG Los Angeles had examined Livent books using KCNT for tax review to give report to purchaser. Purchase goes forward. D doesn’t complain even though report not rosy. Deloitte’s audits Livent.
  • Purchaser believes Livent accounts mask true condition due to D
  • Purchaser suspends D
  • Purchaser hires KC Downtown Toronto Office forensic unit to investigate.
  • Case settled, some files sealed, Drabinsky indicted in US

Discuss possible conflicts of interest

ethical regime international
Ethical Regime - International

Guidance framework includes…

  • IFAC Code of Ethics, CICA Independence Exposure Draft
  • IFAC Code at www.ifac.org/Ethics/
  • GAAP, GAAS
  • SOX, SEC Rules – released Nov. 19, 2002 www.sec.gov

A professional accountant must adhere to a set of rules aimed at neutrality and at protecting the public interest – s/he should not go to absolutely any lengths to serve a specific client’s interests, unless the public interest is also served

conflict of interest independence for professional accountants ifac
Conflict of Interest/Independence for Professional Accountants - IFAC

1. Protect the Public Interest

2. Professional Service to Clients

Judgement

Integrity of Services

Objectivity

ifac conflict of interest independence
IFAC Conflict of Interest/Independence
  • “Regardless of service or capacity, professional accountants should protect the integrity of their professional services, and maintain objectivity in their judgement.” (Sect. 1.2)
  • Integrity… honest, fair dealing, truthful and free of conflicts of interest (1.1)
  • Objectivity … a combination of impartiality, intellectual honesty and a freedom from conflicts of interest (Definitions, p. 5)
limits to serving clients
Limits to Serving Clients

SEC Proposal/Ruling…SEC Registrant Auditors “not independent whenever, during the audit and professional engagement period, the accountant:

1. Has a mutual or conflicting interest with the audit client;

2. Audits the accountant’s own work;

3. Functions as management or an employee of the audit client; or

4 Acts as an advocate for the client.”July 2000, Nov. 2000

SOX/SEC Proposal/Ruling Released Nov. 19, 2002

Letters of Engagement

Legalities

Post-engagement time frame restrictions

ifac code of ethics nov 2001
IFAC Code of Ethics, Nov. 2001

Duty to Society,

Serve the Public Interest

Objectives

Meet Expectations for Professionalism, Performance, Public Interest

Basic Needs

Credibility, Professionalism, Highest Quality Services, Confidence

  • Fundamental Principles
    • Integrity, Objectivity, Professional Competence and Due Care,
    • Confidentiality, Professional Behaviour, Technical Standards
ifac code of ethics
IFAC Code of Ethics
  • Public Interest Requirement: Responsibility to the public ... who rely on the objectivity and integrity of professional accountants to maintain the orderly functioning of commerce. (9, p.10)
  • Objectives involved:
    • to work to the highest standards of professionalism
    • to attain the highest levels of performance and
    • generally to meet the public interest requirement (14, p. 11)
ifac code of ethics15
IFAC Code of Ethics
  • Four basic needs must be satisfied:

credibility, professionalism, highest quality services, and confidence (14, p. 11,12)

  • Prerequisites or Fundamental Principles to be observed to meet objectives:
    • Integrity
    • Objectivity
    • Professional competence and due care
    • Confidentiality
    • Professional Behaviour
    • Technical Standards (16, p. 12,13)
ifac conceptual approach to independence
IFAC Conceptual Approach to Independence

Objective: Independence of Mind & Appearance

To Protect the Public Interest

Identify and Evaluate

Circumstances and

Relationships

that create

Threats To

Independence

Eliminate Threats

or

Reduce to an

Acceptable Level

By Applying

Safeguards

ifac conceptual approach to independence17
IFAC Conceptual Approach to Independence

Objective: Independence of Mind & Appearance

To Protect the Public Interest

Threats To

Independence

Apply

Safeguards

Self-Interest

Self-review

Advocacy

Familiarity

Intimidation

Profession

Legislation

Regulation

Within Client

Within Firm

ifac conflict of interest independence18
IFAC Conflict of Interest/Independence

Independence of mind - the state of mind that permits the provision of an opinion without being affected by influences that compromise professional judgement, allowing an individual to act with integrity, and exercise objectivity and professional skepticism

Independence of appearance - the avoidance of facts and circumstances that are so significant a reasonable and informed third party, having regard knowledge of all relevant information, including any safeguards applied, would reasonably conclude a firm’s, or a member of the assurance team’s integrity, objectivity or professional skepticism had been compromised.

(Def., p. 4)

categories of conflict of interest
Categories of Conflict of Interest

Stakeholder categories Sphere of activity affected Examples

__________________ ________________________ _____________________

Self vs others Services offered Conflicting services, shaving quality

Improper use of influence Improper purchases of client goods

Misuse of information Improper investments by relatives

Self & others Services offered Consulting and other services, and/or vs others over-involvement with management

or Directors erodes objectivity

Client vs client Services offered Serving competing clients

Employer vs employer at the same time

Stakeholder Misuse of information Whistle-blowing, reporting to

vs stakeholder (confidentiality) government or regulators

_____________________________________________________________________________

(Source: Brooks, L.J., Business and Professional Ethics for Directors, Executives & Accountants,

South-Western, a division of Thomson Learning, 2004, Table 4.11

frequent conflicts of interest
Frequent Conflicts of Interest
  • Profit vs... the Public Interest
  • Consulting & assurance services
  • Multi-disciplinary practices (MDPs)
  • Fiduciary or Professional Responsibility
  • Confidentiality
  • Serving Multiple Clients
  • Employees vs.... Profit and the Public Interest
  • Whistle-blowing & Resignation
safeguards created by the profession legislation or regulation
Safeguards created by theProfession, Legislation, or Regulation
  • Education, training, experience requirement for entry
  • Continuing Education
  • Professional standards, monitoring, and disciplinary processes
  • External review of firm’s quality control system
  • Legislation governing independence requirements of the firm

IFAC Code, 8.37

safeguards within the client
Safeguards Within the Client
  • Appointment of auditors ratified/approved by other than management
  • Client has competent staff to make managerial decisions
  • Policies and procedures emphasizing client’s commitment to fair financial reporting
  • Internal procedures to ensure objective choices in commissioning non-assurance engagements
  • A corporate governance structure, such as the audit committee, that provide appropriate oversight and communications regarding a firm’s services

IFAC Code, 8.38

safeguards within the firm s own systems procedures
Safeguards Within TheFirm’s Own Systems & Procedures
  • Leadership stressing importance of independence, and expectation of service/action in the public interest
  • Policies and procedures to implement and monitor control of assurance engagements
  • Documented independence policies regarding the identification and evaluation of threats to independence, applications of safeguards to eliminate or reduce those threats to an acceptable level
  • Policies and procedures to monitor and manage the reliance on revenue from a single assurance client
  • Using partners with separate reporting lines for the provision of non-assurance services to an assurance client
  • +6 other firm-wide +9 specific items IFAC Code, 8.41,2
interesting questions
Interesting Questions
  • Is it wrong for an employee to seek a special deal/ discount/benefit from being employed within a company?
  • Is it acceptable to hold stock in a supplier, customer, client, or other organization doing business with your company/client?
  • Should you snitch on a fellow worker who snorts cocaine on the job?
  • If an accountant learns that a client has deliberately violated building codes, should (s)he report the violation? To?
  • Should a secretary lie to a boss' spouse about his/her whereabouts when the boss is having an affair? What should the secretary do?
comprehensive risk management requires understanding the business
Comprehensive Risk Managementrequires understanding the business

Risk Events Causing Drops of Over 25% Share Value,

Percentage of Fortune 1000 companies, 1993-1998

Strategic ……………………………. 58%

Customer demand shortfall (24) Competitive pressure (12)

M & A Integration problems (7) Mis-aligned products (6)

Operational …………….31%

Cost overruns (11) Accounting irregularities (7)

Management ineffectiveness (7) Supply chain pressures (6)

Financial ………..6%[Foreign macro-eco, interest rates ]

Hazard …….0%[Lawsuits, natural disasters]

Source: Mercer Management Consulting/Institute of Internal Auditors, 2001

comprehensive risk management includes ethics risk management
Comprehensive Risk ManagementincludesEthics Risk Management

Ethics Risk Reputation Success

Reputation is important

  • Arthur Andersen…………… survival
  • RT Capital…………reputational capital
  • Tylenol ……………competitive advantage

Selling trust and credibility, not pills, …

© L. Brooks

comprehensive risk management depends upon the corporate ethical culture
Comprehensive Risk Management depends upon the Corporate Ethical Culture
  • Comprehensive Risk Management utilizes both:

A. Key risk factor identification & measurement

B. Review of key business processes including the ethical culture that underpins process integrity

  • Ethical culture provides guidance for employees about when to adhere to the Code, when actions are not covered in Code, in a grey area, or in a crisis - tools to measure ethical culture do exist

Enron’s Board failed to consider any of this!

Few corporations do A, fewer do B!

emerging risk oriented decision criteria for directors
Emerging Risk-oriented Decision Criteria for Directors

Criteria (New) Interests/Risks Considered

  • Profitability & legality …… Shareholders +
  • Fairness & rights …… Specific Stakeholders
  • Expectations Gap ………. the Public Interest
slide30
Risk Assessment -

The Auditor’s Emerging Role

Why is it important?

What risks are critical?

How can risks be assessed and conveyed?

risk why are auditors interested
Risk: Why are auditors interested?

Better achievement of strategic objectives of:

  • the organization involved
    • to manage risks to reduce problems
    • to take advantage of opportunities
  • the audit
    • to assess risks likely to affect org. policies and compliance, and operational health of the organization
    • to ensure significant risks examined
traditional audit model vs business risk audit models
Traditional Audit Model vs.Business Risk Audit Models

“…the failure to detect processing errors is rarely the cause of audit problems. Rather, the major issues … are more likely to be associated with the manner in which the business entity is managed to achieve its objectives. Factors such as the business environment, governance issues and the nature of managerial control will ultimately have significance for the financial statements – their accuracy, issues of fraud and going concern.”

Developments in the Audit Methodologies of Large Accounting Firms

Lemon, Tatum & Turley, May 2000 (See www.abgweb.com)

why manage risk
Why Manage Risk?
  • More likely to achieve objectives:
    • Identify and exploit opportunities
    • Identify risks and avoid before problems arise
    • Respond effectively to unexpected events
    • Adapt and mitigate negative impacts
    • Make good decisions quickly
    • Preserve and enhance reputation
  • More complex environment
  • Faster pace requires faster response
  • Greater downside and upside

Ref: Managing Risk in the New Economy, CICA/AICPA, 2001

understanding risk
Understanding Risk

Risk is the chance of something happening that will have an impact on objectives.

Risk Management includes the culture, processes, and structures that are directed towards the effective management of potential opportunities and adverse effects

Risk Management Process includes the systematic application of management policies, procedures, and practices to the tasks of establishing the context, identifying, analyzing, assessing, managing, monitoring, and communicating risk

Managing Risk in the New Economy

AICPA & CICA, 2001, p. 4

integrated risk management
Integrated Risk Management
  • Enterprise-wide responsibility, not just by specialists
  • Guidance of risk champion
  • Based on understanding of multiple risks and the integration of risks

Ref: Enterprise Risk Management: Trends and Emerging Practices,

The Institute for internal Auditors Research Foundation, 2001

approaches to erm
Approaches to ERM

A. Key Risk Factors Assessment

  • Identification
  • Analysis
  • Ranking
  • Mitigation/planning

B. Process-control Assessment

  • Identification of flaws, then as above

Enterprise Risk Management: Trends and Emerging Practices,

The Institute of Internal Auditors Research Foundation, 2001, p. xxxi

establishing the risk context
Establishing the Risk Context
  • Appetite for risk depends upon:
    • Corporate philosophy, culture and strategic perspectives (vision, mission and values), relationships with key stakeholders, external environment, and internal environment
  • Capacity for risk includes:
    • The ability to exploit opportunities, and
    • The resilience to market setbacks and catastrophes
risk management context
Risk Management Context

.

RISK MANAGEMENT APPROACH

SET OBJECTIVES

…OPTIMIZATION

DETERMINE

VALUES

ACCOUNTABILITY

AUTHORITY

CRITERIA FOR RISK ASSESSMENT

risk management values
Risk Management Values
  • Commitment to ethics, safety, customer service, product quality, corporate citizenship
  • Risk tolerance
  • Risk limits of lenders, creditors, shareholders
  • Openness to questions
risk assessment criteria
Risk Assessment Criteria
  • Appetite and capacity for risk
  • Policy, goals, objectives, stakeholder interests
  • Operational, technical, financial, legal, social, humanitarian +
  • Materiality
  • Iterative
identifying risks
Identifying Risks
  • Consider both common risks &processes
  • Internal interviewing and discussion – brainstorming, self-assessment, SWOT analysis
  • External sources – comparison, discussion, benchmarking, risk consultants
  • Tools, diagnostics – checklists, analysis: scenarios, value chain analysis, business processes, system engineering` process mapping
  • Cases exist
analysing and assessing risk

High

Moderate

Low

Low

Moderate

High

Analysing and Assessing Risk

A Risk Map

Consequence

Likelihood of Occurrence

Managing Risk in the New Economy, AICPA & CICA, 2001, p.11

analyzing and assessing risks
Analyzing and Assessing Risks

Managing Risk in the New Economy, AICPA & CICA, 2001, p.12

reputation ethics
Reputation Ethics
  • Because of the significant relationship between Ethics and Reputation, should Ethics Risks be a separate category of risk?
  • An Ethics Risk exists whenever the expectations of the public are different than the action under review

Ethics Risk is an idea under development

By L.J. Brooks

slide47

Ethics Risk & Opportunity

Identification & Assessment

Phase 1

Develop a

Projected,

Ranked

Understanding

of Stakeholder

Interests/

Expectations

Phase 2

Compare

Activities to

Expectations

to Identify

Ethics Risks &

Opportunities

  • Phase 3
  • Reports By
  • Stakeholder Group
  • Product or Service
  • Corporate Objective
  • Hypernorm Value
  • Reputation Driver

Reputation Driver: Trustworthiness,

Credibility, Reliability, Responsibility

Identify

Confirmation

Hypernorm: Honesty, Fairness, Compassion,

Integrity, Predictability, Responsibility

Rank: Urgency,

Power,Legitimacy

Dynamic

Analysis

Performance: Inputs,Outputs,Quality