Corporate Governance
Surviving the Storm
More than a year later, the repercussions of U.S. corporate failures are being felt in the Canadian regulatory landscape.
FROM: MAR-APR 2003 ISSUE | BY STEPHEN SPECTOR
As the investigation and analysis of the collapse of Enron continues, one factor has become abundantly clear: the company's board of directors in general, and its executive committee in particular, failed to exercise appropriate responsibility. More than that, they neglected their fiduciary obligations to Enron's shareholders. For example, senior management disposed of their shares granted under option plans, reaping huge profits, while
rank-and-file employees were prohibited from selling theirs. There is also evidence that the Enron board suspended its ethical code and ignored conflicts of interest since some board members ran some of the
special-purpose entities created to move debt off Enron's balance sheet. In addition, it appears that the audit committee's composition rendered it incapable of recognizing what was happening, since its members lacked the knowledge required to recognize the games being played.
In hindsight, it is easy to see where sound corporate governance practices were ignored at Enron. The ramifications, though, go far beyond Enron or any of the other organizations that failed in 2002. John Coffee, a Columbia Universitysecurities-law professor, said it best in a quote that appeared in the June 19, 2002, issue of The Wall Street Journal: "Enron is the private sector's Watergate."
Although not all politicians were crooks, Watergate bred a virulent cynicism about government among the public, the press and even some politicians. The intervening 30 years have done nothing to blunt that cynicism. If anything, the attitude has become ingrained. Unfortunately, Enron and all that followed seem to have done the same for the business world.
Good Governance
Before you can fix a problem, you have to know what the problem is. But, often, you can see what went wrong only in retrospect. One way to prevent problems in an organization's governance structure is to establish what good corporate governance means and ensure that the board adheres to it.
An OECD Observer article, published online in October 2002(http://www.oecdobserver.org/news/fullstory.php/aid/803/ Corporate_governance_and_responsibility:_ Foundations_of_ market_integrity.html ) defines good corporate governance as the following: "the rules and practices that govern the relationship between the managers and shareholders of corporations, as well as stakeholders like employees, pensioners and local communities." The article goes on to say that good corporate governance ensures transparency, fairness and accountability and is a prerequisite for the integrity and credibility of market institutions. "By building confidence and trust, good governance allows the corporation to have access to external finance and to make reliable commitments to creditors, employees and shareholders," the article continues.
When this trust is undermined, lenders and investors lose their appetite for risk, and shareholders offload their equity, resulting in lost value and reduced availability of capital. This applies to every stage of the investment process, affecting issues from property protection and ownership registration, to disclosure and the distribution of authority and responsibility among company departments.
Confidence and trust in the board begins with appointing the right people as directors. The company owners elect the board of directors; however, most owners don't know what a board member is supposed to do. So instead of periodically assessing the skills of the directors, the board perpetuates itself by ensuring the election and/or re-election of individuals who seem to make a career of sitting on boards. This "inbreeding" leads to a lack of perspective and fails to adequately meet the test of good corporate governance.
Good governance means having an effective board spending more time and effort "looking through the windshield," rather than "looking in the rearview mirror," as described in the online research publication Catalyst produced by the accounting and management consulting firm Grant Thornton (http:// www.grantthornton.ca/ mgt_papers/MIP_template.asp?MIPID=95 ). Although the directors need to monitor how management has been performing, their main role is to direct the organization. Clearly, independence is a critical issue; board members must be able to assert their independence. The Grant Thornton article says that if a board is to be effective, it must embrace governance practices that involve "establishing a framework of goals and policies to guide an organization's progress, and then assessing management's results against the objectives established in the framework." Directors must represent the interests of the organization itself by focusing on these interests rather than satisfying the demands of those who appointed them.
But how does the business world ensure that directors do just that? Government and accounting regulatory bodies have stepped into the fray, attempting to clean up the shattered corporate image.
One Size Fits All?
Government has politicized the issue with sweeping legislation — some of it already implemented and some still to come — that supports a one-size-fits-all approach.
In North America, Canada was the first to act. On July 17, 2002, the CICA, the Canadian Securities Administrators and the Office of the Superintendent of Financial Institutions announced the creation of the Canadian Public Accountability Board (CPAB). According to the press release of the day, the CPAB was established "to ensure the independence and transparency" of the system by creating a way of imposing sanctions on auditors and audit firms that fail to protect the public interest. It further stated that a national inspections unit will review audit practices and conduct annual inspections of all firms that audit publicly traded companies. The Board would also have the power to issue reprimands or censure, call in provincial accounting bodies to investigate problems and supervise problem firms. There was no evidence that these actions were necessary, but their imposition played to the public demand for action.
Similar action took place in the United States. On July 30, 2002, President George W. Bush signed into law the Sarbanes-Oxley Act of 2002 "to protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the securities laws, and for other purposes." The Act imposed strict requirements on all parties deemed responsible for the corporate failures making headlines at the time. In general, the Sarbanes-Oxley Actapplies to all publicly owned U.S. companies listed on national exchanges or quoted on NASDAQ, and all companies (regardless of their country of origin) that have registered equity or debt securities with the U.S. Securities and Exchange Commission.
The government actions in Canada and the United States aim to restore confidence in the business community. John Coffee's reference to Watergate is never far from mind. However, these actions ignore the fact that most companies are good corporate citizens and do follow good governance practices.
It is impossible for government to define board responsibilities. This can be done only in the context of each organization. Nevertheless, there is pressure to dictate what some of those duties should be. The Sarbanes-Oxley Act requires the CEO and CFO to certify the veracity of the financial statements. The Toronto Stock Exchange and the Ontario Securities Commission are working to define the role of audit committees beyond what is specified in the various companies' acts. And news reports suggest that additional requirements will be imposed on boards as new regulations are developed, for example, the requirement that the audit committee be composed of a majority of outside directors and also be chaired by an outsider.
Differing Nations
Initiatives taken in Canada suggest the adoption of many Sarbanes-Oxley policies. While this may seem to be acceptable, it overlooks the fact that the great majority of Canadian companies are not public enterprises.
The issue of public interest versus private interest is one that cannot be overlooked. Publicly traded entities have a responsibility to the unsophisticated investor who relies, in whole or in part, on published financial statements for investment decisions. They also owe a duty to creditors who lend funds based on published financial statements. However, it is different for privately held firms, where the risk is substantially lower. The owner is usually part of the management team, and lenders and creditors are not unsophisticated; instead they are knowledgeable individuals who rely on the owners' character and abilities.
The wholesale importation and introduction of U.S.-style regulations into the Canadian regulatory environment is not appropriate. The U.S. economy is an order of magnitude larger than Canada's. In addition, a key component of our economic engine is the small and medium-sized enterprise (SME) sector, which today accounts for a major portion of employment growth in this country. While there are many SMEs in the United States as well, they do not entail the same proportion of employment creation that they do in Canada. Thus, a system based on relationships between large audit firms and large businesses fails to account for the intimate relationships developed between SMEs and the small and medium-sized accounting firms particular to Canada — the type of firm where many CGAs provide their services.
Impact on CGAs
At this point, it is impossible to say what impact these regulatory changes might have on the average CGA. It depends on who you are and what you do. The impact on a member employed in industry might be minimal; however, the impact on a senior executive working for a listed firm will likely be considerable.
In CGA-Canada's presentation to the Senate Standing Committee on Banking, Trade and Commerce in May 2002, the Association suggested the core principle, post-Enron, "goes into the manner in which we operate our accounting businesses and how we separate our private profit motives from our public obligations. It goes into how the corporations we serve — large, medium and small — conduct their affairs, including how citizens involved in commerce are required to separate their public and private responsibilities."
Attest and consulting services provided to SMEs in Canada are important to the Canadian economy and the accounting industry. At the private company level, the accountant is more than just the accountant. He is the confidante, the adviser and resource for SMEs. In light of Sarbanes-Oxley, it appears that at least some services accountants currently provide will become taboo, for example, public practitioners will find certain non-audit services prohibited if their client is an audit client. In September 2002, the CICA released an exposure draft entitled Independence Standards, which proposed strict new requirements to be imposed on auditors. The goal of the draft was twofold: one, to enable listed companies and their auditors to comply with the requirements of the Sarbanes-Oxley Act; and two, to help restore the confidence in the auditor/client relationship severely damaged by Arthur Andersen's conduct in the Enron scandal. The draft may not be adopted as circulated, but at least some of it will eventually be implemented.
From a marketing perspective, the regulatory changes contemplated by the OSC, along with the increased vigilance of the CPAB, may actually provide an opportunity for CGAs to expand the services they offer. CGAs could serve as a consultant to boards of directors. With the emphasis on increased corporate governance responsibilities, CGAs can provide advice on conduct and responsibilities. Members engaged in the public practice can help their clients define the responsibilities of their audit committee, and/or help identify potential committee members. CGAs can help define policies and procedures to ensure that corporate codes of conduct are implemented and adhered to.
So, while the collapse of Enron and other corporate giants in recent years has produced increased scrutiny and regulation that may prevent accountants from providing the full range of services they currently offer, there may still be opportunity for additional services in the new business climate. Once the dust has settled, CGAs and other professionals may indeed find themselves busier than ever in their role as financial adviser to their clients.
| CGA-Canada's Restoring Confidence Task Force
The investing community's trust in the information presented in published financial reports has been a victim of the Enron affair. The conflict of interest between Enron and its auditors, Arthur Andersen, has also raised the issue of the reliability of the auditor's report accompanying published financial statements.
In September 2002, the CGA-Canada Board of Directors created the Task Force on Restoring Public Confidence in Financial Reporting to address a broad range of professional accounting issues related to the many post-Enron developments taking place in North America. The mandate of the task force was to develop positions for the Association related to the general loss of credibility in financial statements following the events of the past year. The task force was also charged with assisting CGA decision makers in matters affecting protection of the public, as well as representing the interests of CGAs to regulators and directing other Association committees in the development of new standards and regulations that might be needed.
In addition, the task force was asked to assess how proposed changes to the regulatory and legal environment might impact the auditing process for small and medium-sized businesses, especially if one consequence of these changes was the risk of greater concentration in attest service providers. Finally, the task force was to consider how corporate governance processes could be improved, particularly for the SME sector; what regulations might be required of corporate audit committees; and finally, the possible need for greater penalties and sanctions in the event of corporate fraud.
Chaired by Luc Provencher, FCGA, special adviser to the president and chief executive officer of the Business Development Bank of Canada, the task force submitted its interim report to the December 2002CGA-Canada Board meeting. Look for updates in upcoming editions of "News from CGA-Canada" for further developments.
Governance Online
Since its inception in September 2001, the CGA-Canada Professional Development Network — PDNetwork (www.cga-pd.net) — has functioned as a resource for members seeking information and the latest news regarding current developments in the accounting profession. The fallout from the Enron debacle has generated reams of reports and countless articles, both in print and on the Web. Of the resources available on the PDNet, one series may be of particular interest. Authored by Michelle Causton, FCGA, this three-part series examines governance issues.
In "Governance — An Overview," Causton discusses what governance entails and whose responsibility it is. The author notes that in a free-market society, investors and others must be able to trust the corporations they deal with. In light of the recent scandals, there has been a cry for tougher laws, more transparency, more regulations, greater oversight and more government protection. But are these the proper remedies to the ills of the business world?
In "Management's Role," the focus shifts to management's role in good governance and tips for building a better board. The discussion addresses requirements for listed companies and includes indicators to identify when matters require attention.
The third part, "Accountability and Governance in the Voluntary Sector," changes focus, as its title suggests, to address accountability and governance issues particular to the voluntary sector. While many large not-for-profit organizations, such as the United Way, have well-defined organizational structures and policies, it is the smaller, volunteer-type entities where the most trouble arises. Given the limited number of volunteers and the relative lack of experience, small not-for-profits are proof of the adage that the road to perdition is paved with good intentions.
Causton concludes the series with a list of additional reading that will be of interest to those affected by these issues. |
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Stephen Spector, MA, FCGA, owns Spector and Associates and teaches Financial and Managerial Accounting at Simon Fraser University. He also serves on CGA-BC’s board of governors. E-mail shspector@shaw.ca.