Choosing wisely: some corporate directors may be stepping down from their posts over the next few months. Those who fill their shoes can expect more scrutiny, more accountability, and more penalties for negligence

Internal Auditor, Feb, 2003 by Alan Gersten

SIGNED INTO LAW IN 2002, THE Sarbanes-Oxley Act was in direct response to the corporate misconduct committed at such companies as Enron, WorldCom, and Tyco. With the beginnings of its implementation in progress, the business community is reacting. "What's happening now is a sea change," said panelist and former U.S. Secretary of Commerce Barbara Hackman Franklin. "We each need to take a deep breath and let it all settle down." Some can breathe deeper than others. "It's been my experience -- and I'm happy to say this -- that a lot of what is now required has largely been in place at the five boards I've been associated with over these past 20 years," said Peter Tobin, who's currently on the board of directors of AXA. Financial Inc. and The Equitable Life Assurance Society. For instance, he pointed out, from 1992 to 1997, when he was the chief financial officer of a large New York bank, the chief executive officer (CEO) and the controller certified the financial statements of the bank, a process that continues to the present day. * Although many of the so-called reforms outlined in the Sarbanes-Oxley Act are already in place at good companies, a large slice of the corporate arena hasn't even started to figure out what their problems are. Without these reforms, the panelists warned, auditors, officers, and directors could face huge monetary fines and, far worse, jail time. * "It's clear that, at the very least, complacency has crept into the system," Tobin said. "At the very worst, there has been, as we know, outright accounting and disclosure fraud and probably a lot of gray in between for a lot of companies that were just not sure what's actually going on. I must say, as an audit committee member, I actually welcome the new legislation."

IMPENDING CHANGES

To Tobin, who serves on five different boards and is chairman of two audit committees, Sarbanes-Oxley has significantly tightened up the requirements for sound corporate governance and, perhaps most importantly, established criminal penalties for executives, accountants, and even possibly board members. "I am, in effect, what some people call a financial expert," said Tobin, who is a certified public accountant. "Now, I approach the signing and certification as if I was going to be criminally liable if I did something inappropriate."

Franklin, the president and chief executive officer of international consulting and investment firm Barbara Franklin Enterprises, thought a company needed a good board of directors to help bring credibility back to the accounting profession. After the debacle at Arthur Andersen, no one in the audience even raised an eyebrow.

Most directors, continued Washington, D.C.-based Franklin, who is also an audit committee chairman, will do their best to implement the changes, many of which started before Sarbanes-Oxley passed. "After Enron, directors sat straighter in their chairs and the audit committee had an incentive to look at the workpapers," she added. "This meant longer meetings, more substantive meetings, and audit committees that were more vigilant. There was more care in the boardroom."

For Franklin, this turn of events strengthened the checks-and-balances system between management and auditors. There was more than one independent entity questioning management, which exacerbated tension between management and directors. With such checks and balances, "We won't have the Jeff Skilling dance," Franklin quipped, referring to the president and CEO of Enron's testimony in front of Congress, where he contended he knew nothing about the company's financial improprieties.

Today, if the financials are fraudulent, the CEO and CFO, who have certified the statements' accuracy, pay the price. "This means higher and tougher standards for certification," Franklin said. "In turn, that will enhance the checks-and-balances system."

In addition, the audit committee is responsible for the compensation and work of the outside auditor. That way, he or she answers to the committee, not the CEO, Franklin continued. Again, that creates more independence, more checks and balances.

Perhaps because of the stiffer penalties, not all directors are willing to make the effort, said panel moderator Roger Raber, president and chief executive officer of the National Association of Corporate Directors (NACD). Some would rather flee than fight, he added: "We'll see some people stepping down as directors and others saying it's not worth it."

DO THE DUE

Like many at the conference, Tobin warned the audience about the dangers inherent in the Sarbanes-Oxley reforms. For instance, anyone invited to join a board should conduct a thorough due-diligence of the boards on which they are invited to sit. He recommended that anyone considering such an appointment makes sure the company has a good, strong, and capable CEO, a factor that often translates into a strong board. "Tone at the top is everything," Tobin explained. "If the CEO does not have a strong internal control mentality and a strong position relative to using the right accounting approaches, it can permeate the company pretty quickly, and can be its downfall."