Economic Crisis –
Auditors Evolving Role
IAA Charlotte March 17 2010
Michael P. Cangemi CPA, CISA
Former CAE - CEO Etienne Aigner & FEI
Advisory Board Member – FASB, COSO
Management, IT, Financial Governance
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Cangemi Company, LLC
Business Career
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Merrill Lynch/Blair&Co – High School&College
Ernst & Young – CPA – Dir IT Audit
Phelps Dodge – CAE – VP - CIO
Professional work – IS Control Journal (8707) & 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
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Cangemi Company, LLC
Leverage infused Credit Crisis
Lehman Brothers – wiped out
 Bear, Merrill, Wachovia – merged
 200+ banks taken over by FDIC
 32-1 leverage – more on this risk later
 AIG- regulated company – Gov take over
 GM- non -regulated – Gov take over
 " Greenspan said, "We are in the middle
of a once-in-a-century credit tsunami."
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Today’s Goals:
Managements Prospective
1. Crisis – impact on your business
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2.
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Recession puts pressure on costs – even
audit and recently IT spending; efficiencies
from IT have been #1 cost reduction driver
What else auditors should be doing!
Fraud risk always present: rises in
downturns – but always present!
Credit Crisis - Primer
Recent History
 What caused this Credit Crisis
 Easy Monetary Policy
And
 A simple financial instrument
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Sub-Prime Malfeasance
A mortgage was a safe loan
 Securitizations -Packaged into Mortgage
Backed Bonds – Fee income for IB
 Packages of Mort-Backed Bonds into
Collateralized Debt Obligations (CDO)
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Good collateral – until no money down,
interest only, credit scores don’t matter
House 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
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Cangemi Company, LLC
Market Cycles 101
Blame game
Lax Credit criteria – system of moving
risk to others – after taking fees
 Unregulated mortgage brokers
 Add 2% and 20% --- leverage
 Lack of adequate regulation –CDO’s
 Soft regulation on Short selling
 Rating Agencies – big issues!!
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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
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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 –
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Federal reserve gains regulatory power
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Financial Services Oversight Council
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over “too big to fail” institutions
Addresses gaps in regulation
Consumer Financial Protection Agency
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new rules over credit cards, mortgages and
other consumer products
Three selected Mega Trends
1.
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Sever recession – credit contraction
Globalization - Competition
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Rise of Elephant & Dragon; Brazil etc.
Expansion of Global Capital Markets Global Shift:
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3.
2003 US was 44% - 2007 33%
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
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Market has come back – avoided crash
Management Perspective -much higher
unemployment
Lower consumer spending – lower USA GDP
New Playing Field
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Eco Crisis leads to BIG changes –
GM Bond holders lose to employees
 Gov takes equity and management
decisions
 Fed - systemic risk regulator;
 SEC-PCAOB?
 New consumer regulator
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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
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Cangemi Company,
React to the New Normal
US will be less of an economic power
 Maybe US $ replaced by a basket
 More outsourcing – to lower cost
countries – accounting, audit & IT
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Difficult Business environment – should
lead to innovation – lots of changes
New Normal – Audit –IT Audit
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Get in the flow with management
My Book: Periodic Audit Mgt Change
 Innovate/Reinvent - Respond
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Larger focus on formal ERM - GRC
 To Do- Lower cost – higher imagination
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COSO Continuous Audit & Monitoring
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Discuss 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
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Audit Involvement in ERM
Basically a good thing – to a degree
 BUT – What is ERM and note it works
until management overrides
 Leman; Merrill; Bear – had risk models
 Trying to apply Fin Company risk model
My advice:
 Set your Audit Charter realistically
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Leverage – 1929 in a new form
32 to 1 – are you kidding!!
Say you raise $10,000,000
 Now investing $320,000,000 - OPM
 Earn 2% Fee = $6.4 M vs. $10 M raised
Did IA have a risk comment – ERM ??
Buffet’s comments in DC : 2% & 20% rule
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COSO - ERM
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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 deliverables
 IA – People, Procedures – Reports
 Take advantage of automation
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IA Adding Value – ROI
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Use of Technology –
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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
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COSO Cube
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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 & Oversight
 Oversight Systems
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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
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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.
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threshold-oriented reports automatically
alert audit professionals
Audit Dash boards
Click-through to Relevant
Exceptions
© 2007 Oversight Systems
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Plain Language Exception
Descriptions
© 2007 Oversight Systems
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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
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Financial Scandals are not a new
phenomena
Management, IT, Financial Governance
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Cangemi Company, LLC
Recent Financial Market Crises
1980s Saving & Loan Bailout
 1987 Market drop and rapid recovery
 1998 Long-Term Capital failure & fallout
 9-11-2001 – terrorist attacks
 2001-02 - accounting scandals and
bankruptcy's –some caused by bad guys
 2007-08 sub-prime induced dislocationsome again caused by bad guys
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Discovery of America – New Land Schemes
Management, IT, Financial Governance
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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 Bubble
 1990’s Internet Bubble
 2000’s corporate frauds leads to SOX!
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Management, IT, Financial Governance
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Cangemi Company,
Bad Guys circa 2009 - Global
Société Générale
– one trader $7.2 billion loss
 Bernie Madoff – never bought a security
 Texas financier R. Allen Stanford -sold
CDs in US kept the cash –Global Fraud!
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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 efficient
Business run on cash
Try for cash recoveries
Lower expenses
Careful expanded focus on GRC- ERM
Be creative – innovate – high imagination
low cost solutions – use automation
Think Globally
Management, IT, Financial Governance
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Cangemi Company, LLC
Questions?
Management, IT, Financial Governance
42
Cangemi Company, LLC
Cangemi Company LLC
Senior Advisor & Board Member
 Consulting –Financial, Strategic &
Governance , Internal Audit
 Media -speaking; teaching
 Book -Managing the Audit Function;
available at Amazon, Wiley and other
book sellers
 mpcangemi@msn.com
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Management, IT, Financial Governance
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Cangemi Company, LLC