Restoring investors’ confidence

Hong Kong's Institute of Internal Auditors believes the city remains vulnerable if another global financial crisis strikes — and seeks a greater role, through implementation of more stringent controls.mini storage Wong Joon San reports. Hong Kong investors have never regained their trust in financial institutions, since reckless international bankers touched off a massive wealth shift and nearly destroyed the global economy back in 2008. Investors remain suspicious of corporate brigands, after stocks of many companies were manipulated then they went bust. It seems many investors are standing around with their hand in their pockets waiting for another round of corporate highway robbery. Stephen Lee, president of the Institute of Internal Auditors Hong Kong Ltd, says: "In the Asian or Hong Kong context, (financial fraud has been) accentuated by twin parameters. Investors don't have confidence and the trust in corporate governance in general." The Institute of Internal Auditors in Hong Kong is one of the largest branches of the umbrella body of the Institute of Internal Auditors with 800 members. The global body serves 180,000 members in 190 countries. "Any sign of something negative, they react very quickly in Hong Kong and in China (by selling their stocks). The other aspect of this is the companies themselves don't react proactively, but take a long time to respond. "In the time between allegations (concerning a stock) and the response by the company, nobody knows what is happening. Everyone starts selling. Investors get frightened," Lee says. During the ensuing turmoil, short sellers can make a lot of money, he adds. "We have companies that are not prepared to react in a holistic and a frank way to those (damaging) allegations. The end result is that for a protracted period, investors do not know what is happening, do not know who to believe, and don't know whether the rumors are true or not. Shares will become volatile and stock prices will plunge," Lee says. He was commenting on an October report in the Guangzhou-based New Express newspaper, regarding alleged financial problems at Zoomlion Heavy Industry Science and Technology Development. Shares in the company, a leading manufacturer of concrete-pumping equipment in Hunan took a severe hit, losing 1.4 billion yuan ($229.7 million). During subsequent investigations the reporter confessed he had accepted money from an unnamed third party to write the damaging stories about Zoomlion. Financial fraud During his tour in Asia and visit to Hong Kong to promote the internal audit profession, Richard F Chambers, president and chief executive officer of the global body of the Institute of Internal Auditors, told China Daily that: "For 2013, we (at the global body) are already starting to look ahead at internal audit focus by global financial services regulators. "We have seen the US Federal Reserve Board and some of the other financial regulatory authorities around the world who have taken note of the fact that internal audit in financial services must be independent, and they are prescribing this to reporting relationships that internal auditors have. "The Federal Reserve had earlier this year said the internal audit of the largest (US) banks with assets of $10 billion and over must report (directly) to the bank's chief executive officer (CEO) and the audit committee for banks," he said. "We are noting the adoption of the new framework of the Committee of the sponsoring organizations of the Treadway Commission (Coso), which updates internal control framework of companies, now updated for the first time in 21 years," Chambers says. "Companies globally, including those in Hong Kong are required to adhere to and implement the Coso framework by 2014. The Institute of Internal Auditors is one of five organizations that sponsors Coso," Chambers says. He also points out that: "We are also noting increased emphasis on technology risks, and the things that internal audits are looking at, including cloud computing and mobile technology. These are all risks that will define internal audit coverage in the year ahead," he says. Asked about the progress of internal audits in Hong Kong and Asia in the last five years, Chambers replied that good had been made progress, but he points out there's still much work to be done. Internal audits of many companies continue to report directly to CFOs. Internal audits should instead report directly to CEOs and boards of directors. Regarding financial risks, Chambers says: "No country is immune (from financial fraud). We have seen it with Enron (the scandal, revealed in October 2001, which eventually led to the bankruptcy of the Enron Corporation, an American energy company based in Houston, Texas) and a number of other cases worldwide." Chambers also cited the oil major, BP, the company responsible for the catastrophic oil spill in the Gulf of Mexico. The incident also delivered massive damage to BP's shareholder value. "These are critical risks that were overlooked. Boards should have identified the business risk or reputational risk, but such risks are often overlooked," he says, adding that BP was able to recover. Regarding the Zoomlion case, Chambers says: "I would say it儲存is more of a cultural conflict within the industry of these companies. And from what we have seen in other situations around the world with similar characterization, it is very important for a board to set long term expectations of management, because too often management is rewarded based on short term performance. "So what happens to share value next year and what kind of net profits can the company generate next year? That is how management is rewarded. That kind of short term expectation or measurement can drive behaviors in many instances that are not healthy in the long term welfare of the company. We have seen compensation plans for executives set in short term and not healthy of the company's long term plan," Chambers contends. Phil Tarling, current chairman of the Institute of Internal Auditors (2012-13), who was also in Hong Kong during the same tour, says: "The classic case that came out of Asia is the Barings bank scandal. The bank's internal audit team in Singapore actually detected that (Nick) Leeson had front end and back end access to funds (functions usually performed by two people) and reported him back to London. "If you read Leeson's book — Rogue Trader — Leeson said I thought I was caught (when the UK bank learnt of his unsupervised derivatives trading and an error account). However, management was so taken in by the allegedly good profit of the Singapore office that they ignored the advice of internal audits," says Tarling, who is also vice-president of the Internal Audit Centre of Excellence, based in the United Kingdom. Tarling says: "Internal audit can only advise management what to do, and it is up to the management to act, and in serious cases, internal audit escalates to the board. If the board does not want to do anything, the internal auditor can seek a job elsewhere." Commenting on financial fraud, Lee says that the Hong Kong corporate governance code requires that one third of board members be independent directors, and that the majority of audit committees must have independent directors as well. "In the Asian context, there are many family-owned companies which are also publicly listed. So, having independent directors helps (in prevention of financial fraud)," he says. Turning to China, Chambers says there does seem to be good recognition of internal audits on the mainland. "China is one of the institute's most stalwart organizations in advocating good internal audit practices and good reporting, (at least) one of the strongest on paper at the board and operational level," he says. Risk management Asked what went wrong at HSBC Holdings Plc and Standard Chartered Bank which were fined by US authorities for money laundering offences last year despite having internal audits, Chambers says: "There is always a tendency whenever something goes wrong in a company or in a broader sense the question that will arise is 'where were the internal auditors?'. "And I think that implies internal auditors can be omnipresent and we can look at everything that goes on in a company. That is simply not possible. Companies are far too complex and too vast. I can't comment on any particular case." Chambers continues: "A good strong internal audit function means the internal audits do sit down with board and management, regulators and others, and to assess risks. And if they assess that the risk of money laundering is considered to be a key risk, and then there ought to be internal audit coverage that assesses whether controls are adequate to keep that from happening. So I don't know what happen in the (HSBC and Stanchart) cases you were referring to. But just because there was money laundering, doesn't mean there was a failure of the internal audit functions. Because there is no way a single function within a company can prevent every breakdown of controls." According to a survey of internal company auditors' which generated 17,000 responses and many other interesting trends, Chambers says as many boards of companies do not place great importance on risk management and reporting lines of their internal auditors, so these needed to be improved for more effective fraud control. When boards and management are aware that internal auditors are looking over their shoulders, the tendency for fraudulent financial reporting will be reduced greatly. The institute is calling its members worldwide to ramp up their roles to prevent another global economic crisis, and is advocating better sound risk managements systems and to ensure boards take a greater responsibility for them. Contact the writer at joonsan@chinadailyhk.com In the Asian or Hong Kong context, (financial fraud has been) accentuated by twin parameters. Investors don't have confidence and the trust in corporate governance in general." Stephen Lee president of the Institute of Internal Auditors Hong Kong Ltd No country is immune (from financial fraud), and we have seen it with Enron (the scandal, revealed in October 2001, which eventually led to the bankruptcy of the Enron Corporation, an American energy company based in Houston, Texas) and a number of other cases worldwide." Richard F Chambers president and chief executive officer of the Institute of Internal Auditors 迷你倉