Who's on Your Board?

The Auditing Standards Board has recently responded to the increased awareness of fraud with several standards designed to assist the independent auditor in assessing risks and communicating those risks to the appropriate party or parties. Of particular note is Statement of Auditing Standards No. 114, The Auditor's Communication with Those Charged with Governance ('SAS 114'). SAS 114 requires auditors to communicate discovery of any illegal acts, their consideration of fraud during an audit, and other matters related to corporate governance. One of the interesting points of this standard is that it includes those charged with strategic direction as well as those responsible for financial reporting. This standard has the potential to place responsibility for certain items directly with board members and audit committee members, in addition to management. SAS 114 applies to publicly traded and privately held companies alike.

The communication of these matters to the audit committee is a great first step in dealing with potential fraud, but knowledge is only the beginning. The audit committee and board of directors must be able to deal with these matters once they are communicated.

One step companies can take when assessing these risks is reliance on the advice and experience of financial professionals. The Association of Certified Fraud Examiners has advocated the practice of all public companies including a Certified Fraud Examiner, or CFE, on their audit committee. At the same time, the American Institute of Certified Public Accountants has developed an Audit Committee Toolkit, making the suggestion that every audit committee include at least one 'qualified financial expert.' The implication is clear. If companies are concerned about minimizing the risk of fraud, they need to enlist the help of people who are trained in such matters.

CFEs, commonly referred to as forensic accountants, have extensive training in financial analysis, investigative techniques, internal controls, and risk assessment. Many organizations do not have employees with these skills, but they are crucial to providing a clear understanding of what is needed to protect the assets of an organization. In response to the need for this expertise, large corporations are starting to hire forensic accountants in-house. Smaller companies often do not have the resources to hire people with this expertise.

Publicly Traded Companies

For publicly traded companies, Congress responded to these corporate scandals by passing the highly publicized Sarbanes-Oxley Act of 2002 ('the Act') that was introduced to protect investors and the public from fraudulent activity. The requirements of the Act are many, and enforcement is the responsibility
of the Securities and Exchange Commission. One such requirement states companies must create an audit committee and disclose whether there is at least one financial expert on the committee. This legislation helps to deal with the problem for publicly traded companies, but does not address privately owed businesses.

Small Businesses

The difference is staggering when comparing the numbers of publicly traded and privately owned companies. The U.S. Chamber of Commerce states there are approximately 17,000 publicly traded companies in the United States, but there are approximately 25.8 million small businesses. Certainly there is some overlap in those numbers, but they give a rough illustration of the disparity between the number of public and private companies. This leaves a large portion of the business community overlooked when it comes to the audit regulations. For these nonpublic companies there may not be a requirement to enlist a financial expert, but it is probably a sound decision to do so. If fraud is a great concern, look to get help from those with the appropriate skills.

According to the 2006 Association of Certified Fraud Examiners' Report to the Nation on Occupational Fraud and Abuse, 36% of all fraud reported occurred in companies with less than 100 employees. Another 20.3% occurred in companies having between 100 and 999 employees. Some believe these companies make better targets simply because they do not have the resources or ability to establish the necessary controls. This would mean, by their very nature, small businesses are at a greater risk to be a victim of fraud.

Conclusion

For companies of all sizes, the decisions made in the boardroom will affect how they operate and may ultimately determine success or failure. Whether in response to legislation or good business sense, the use of forensic accountants at the boardroom level will become more prevalent as management responds to the pressures for establishing controls aimed at preventing fraud. Making wise decisions at this level may keep your company from becoming the next headline.

Jeffrey Willoughby, CPA, CFE, is an associate with Forensic Resolutions, Inc, focusing full-time on forensic accounting services Prior to joining Forensic Resolutions, Inc. he worked with several small and medium-sized certified public accounting firms providing tax, audit, and consulting services. His case experience includes commercial litigation, lost income calculations, and insurance claims, among others.

Certainly most, if not all of the business community is aware of the corporate scandals of the past few years; Enron, WorldCom, and Tyco, just to name a few. These business failures not only affect employees and management, they affect the families of all employees, stockholders, and any person or company with which these companies conducted business.

As tragic as the loss of jobs, loss of retirement savings, and costs to prosecute are, there is something that could be worse: knowing that all of it could have been prevented. Each one of these companies had an audit committee that was ultimately responsible for overseeing the audit and issuance of financial statements. This is not to say each of these scandals was completely the fault of the audit committees or the boards of directors. However, some steps could have been taken to minimize these risks.

Statement of Auditing Standards No. 114

The Auditing Standards Board has recently responded to the increased awareness of fraud with several standards designed to assist the independent auditor in assessing risks and communicating those risks to the appropriate party or parties. Of particular note is Statement of Auditing Standards No. 114, The Auditor's Communication with Those Charged with Governance ('SAS 114'). SAS 114 requires auditors to communicate discovery of any illegal acts, their consideration of fraud during an audit, and other matters related to corporate governance. One of the interesting points of this standard is that it includes those charged with strategic direction as well as those responsible for financial reporting. This standard has the potential to place responsibility for certain items directly with board members and audit committee members, in addition to management. SAS 114 applies to publicly traded and privately held companies alike.

The communication of these matters to the audit committee is a great first step in dealing with potential fraud, but knowledge is only the beginning. The audit committee and board of directors must be able to deal with these matters once they are communicated.

One step companies can take when assessing these risks is reliance on the advice and experience of financial professionals. The Association of Certified Fraud Examiners has advocated the practice of all public companies including a Certified Fraud Examiner, or CFE, on their audit committee. At the same time, the American Institute of Certified Public Accountants has developed an Audit Committee Toolkit, making the suggestion that every audit committee include at least one 'qualified financial expert.' The implication is clear. If companies are concerned about minimizing the risk of fraud, they need to enlist the help of people who are trained in such matters.

CFEs, commonly referred to as forensic accountants, have extensive training in financial analysis, investigative techniques, internal controls, and risk assessment. Many organizations do not have employees with these skills, but they are crucial to providing a clear understanding of what is needed to protect the assets of an organization. In response to the need for this expertise, large corporations are starting to hire forensic accountants in-house. Smaller companies often do not have the resources to hire people with this expertise.

Publicly Traded Companies

For publicly traded companies, Congress responded to these corporate scandals by passing the highly publicized Sarbanes-Oxley Act of 2002 ('the Act') that was introduced to protect investors and the public from fraudulent activity. The requirements of the Act are many, and enforcement is the responsibility
of the Securities and Exchange Commission. One such requirement states companies must create an audit committee and disclose whether there is at least one financial expert on the committee. This legislation helps to deal with the problem for publicly traded companies, but does not address privately owed businesses.

Small Businesses

The difference is staggering when comparing the numbers of publicly traded and privately owned companies. The U.S. Chamber of Commerce states there are approximately 17,000 publicly traded companies in the United States, but there are approximately 25.8 million small businesses. Certainly there is some overlap in those numbers, but they give a rough illustration of the disparity between the number of public and private companies. This leaves a large portion of the business community overlooked when it comes to the audit regulations. For these nonpublic companies there may not be a requirement to enlist a financial expert, but it is probably a sound decision to do so. If fraud is a great concern, look to get help from those with the appropriate skills.

According to the 2006 Association of Certified Fraud Examiners' Report to the Nation on Occupational Fraud and Abuse, 36% of all fraud reported occurred in companies with less than 100 employees. Another 20.3% occurred in companies having between 100 and 999 employees. Some believe these companies make better targets simply because they do not have the resources or ability to establish the necessary controls. This would mean, by their very nature, small businesses are at a greater risk to be a victim of fraud.

Conclusion

For companies of all sizes, the decisions made in the boardroom will affect how they operate and may ultimately determine success or failure. Whether in response to legislation or good business sense, the use of forensic accountants at the boardroom level will become more prevalent as management responds to the pressures for establishing controls aimed at preventing fraud. Making wise decisions at this level may keep your company from becoming the next headline.

Jeffrey Willoughby, CPA, CFE, is an associate with Forensic Resolutions, Inc, focusing full-time on forensic accounting services Prior to joining Forensic Resolutions, Inc. he worked with several small and medium-sized certified public accounting firms providing tax, audit, and consulting services. His case experience includes commercial litigation, lost income calculations, and insurance claims, among others.