Somewhere Between Survival and Status, Did Substance Fall Through?
Three “S” words govern internal auditors’ thinking about themselves and their profession: survival, status, and substance. For the past 20 years, we have worried perhaps excessively about survival and status, and not enough about substance.
Until the 1980s, internal auditors did not give much thought to survival. As corporate restructuring, business process re-engineering, leveraged buyouts, and mergers and acquisitions swept businesses aside, we realized we needed to work harder to get management to understand the value we added/retained/protected. So, we shifted the emphasis to new skills, especially soft skills, as a way of becoming better ambassadors for ourselves. We softened our duty to “advise management” (a rather stern phrase) by including it within the envelope of “consulting” activities.
Those who cut their audit teeth in the 1970s (me amongst them) would readily recognize this shift as a necessary corrective. It made us and our profession more presentable, more in keeping with the requirements of a 21st century workplace.
Our quest for survival was also successful because of the rocky history of business during the past 20 years — the savings and loan crisis, the Asian financial flu, the fall of Enron, etc. We converted each seismic event in business into an opportunity. We worked with regulators worldwide to ensure internal auditing would be somehow part of the regulatory response — Sarbanes-Oxley (or its equivalent in most countries), reforms in corporate governance, reporting on entity-level controls, and ERM, CSR, GRC, and all the rest of that alphabet soup.
Survival ensured, we turned to status. Armed with our new-found soft skills, we spent a decade or more pushing to make sure the chief audit executive (CAE) would report to the audit committee rather than to the CEO or chief financial officer. We successfully managed to make it a “best practice” for the CAE to have a seat not only at the executive table but also in the boardroom.
Great. Mission accomplished. Survival assured. Status elevated and cemented. Right? Not quite.
Early analyses of the current financial crisis, including the recently released report of the Inquiry Commission appointed by the U.S. Congress, indicate that the collapse of the house of cards had been more than a decade in the making. Banks, mortgage refinance companies, insurance companies, rating agencies, hedge funds, regulators — all began their risky journey in the mid 1990s, stepped on the gas after 2001, and finally drove off the cliff in 2007 and 2008.
The commission’s conclusions (on pages xv to xviii of the 662-page report) are humbling:
- “This crisis was avoidable.”
- “Widespread failures in financial regulation and supervision.”
- “Dramatic failures of corporate governance and risk management at many systemically important financial institutions.”
- “Combination of excessive borrowing, risky investments, and lack of transparency.”
- “Government ill prepared for the crisis.”
- “Systemic breakdown in accountability and ethics.”
- “Collapsing mortgage-lending standards and mortgage securitization pipeline.”
- “Over-the-counter derivatives contributed significantly.”
- “Failures of credit rating agencies were essential cogs in the wheel of financial destruction.”
Internal auditing comes off almost honorably in the commission’s report. For example (page 157), the report documents how the internal audit department at New Century, the second-largest subprime lender in the United States, “identified numerous deficiencies in loan files and gave the company’s loan production department an ‘unsatisfactory’ rating seven times” out of nine in a single year. For its pains, the internal audit department’s budget was cut.
Elsewhere (page 160), the report concludes:
“Across the mortgage industry, with the bubble at its peak, standards had declined, documentation was no longer verified, and warnings from internal audit departments and concerned employees were ignored.”
Yet, there is also a faint whiff of disapproval about where internal auditing may not have measured up. The Inquiry Commission notes, for example, that the New York Fed’s supervision of Citigroup had “lacked the appropriate level of focus on [Citibank’s] risk oversight and internal audit functions.” (Page 303)
As I see it, internal auditors have two options. The easy one is to heave a collective sigh of relief at getting off so lightly in this weighty report and pretend nothing really happened. The alternative is to recognize that we may have failed to spot something momentous even as it was happening.
How much distance, after all, can we place between ourselves and “dramatic failures of corporate governance and risk management” on a global scale? Especially when, through the same period that these failures were building up, we were working tirelessly to augment our status and be part of the highest levels of corporate governance? With our now-established access to the audit committee, can we still plead ignorance of a “systemic breakdown in accountability and ethics”? Did we, like all the other actors in this decade-long drama, too readily “embrace mathematical models as reliable predictors of risks, replacing judgment in too many instances”?
The echo in the report’s conclusion is familiar:
“We must also accept responsibility for what we permitted to occur. Collectively, but certainly not unanimously, we acquiesced to or embraced a system, a set of policies and actions, that gave rise to our present predicament.”
How we “accept responsibility,” how we shape our role anew, how we fashion our value proposition — these are the challenges that we must address. In a prophetic February 1998 interview with Internal Auditor (“Soft, Dangerous, Essential”), James Roth challenged us to understand how we would “help management control an organization that is much looser, freer, and potentially more chaotic.” That moment of reckoning has now come.
It’s time for us to go back to the one “S” word we may have too long ignored: substance. What is the DNA of internal auditing in the 21st century, and how is it recognizable in the work we do? In my view, this discussion transcends simple survival and status.
Posted on Feb 14, 2011 by Tim
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