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Verification key to financial market rebound. (Viewpoint).

Trust, but verify: Ronald Reagan's philosophical mantra during arms treaty negotiations with the Soviets in the 1980s was based on the premise that when it comes to human nature, without verification, trust eventually is eroded. We see that lesson in the current crisis surrounding the loss of investors' confidence in the reported numbers of public companies.

The heart of the issue is verification: Whose numbers do you trust? The numbers that can be verified. Not enough boards, investors and senior managers have valued verification of basic financial reporting facts and standards. Inevitably, Congress and the Securities and Exchange Commission have tightened the legal and regulatory requirements for external auditors. Audit committee requirements likely will be modified, and there may be internal auditing reforms, as well.

But for internal auditing, companies shouldn't wait to be told what to do. Beyond the scramble to restate their numbers, companies should take a number of steps to reestablish trust in their financial reporting.

1. Value and respect the auditing process. Thirty years ago, Arthur Andersen was known for the rigors of its St. Charles training center, a sort of Marine boot camp for the accounting profession. By the 1980s, however, Andersen and the other major accounting firms turned the basic audit service into a loss leader to their consulting services. The quarterly session with the audit partner that had once been a respectful give-and-take became a sales call for consultancy by the 1990s. The end result: corporations got bigger and more complex, with more sophisticated information systems, but audit resources did not keep pace.

Today, boards and senior managers must commit to the sanctity and efficacy of the auditing, process and assert their will into verifying the results. This task requires their moral, ethical and intellectual commitment, as well as a financial one.

We are seeing some signs of this happening. A year, Russell Reynolds Associates had been asked to find only one head internal auditor for a major company in the prior five years. In the last six months, we have undertaken these searches have indicated that a primary motivations has been the intensifying pressure for verification of their financial report.

2. Compensate the internal auditor as you do the comptroller. Corporations may be forced to accept higher fees (previously discounted) and demand more rigorous audit services from their external accountants to improve verification. The same is true internally. The board and senior management must commit the will and the resources to put the internal auditor on a par with the comptroller.

With few exceptions, however, we are not seeing that happen. In most cases, companies "discount" the auditing function by 30 percent or more.

3. Provide the platform to challenge the process. Provide the internal auditor support and access to the board, the CEO and the CFO, and give the auditor the platform to challenge the company's financial and operating processes. Only through respectful and mutual give-and-take can honest mistakes be uncovered and legitimate accountancy be verified.

One appropriate shift in the auditing function over the last decade has been away from strictly financial audits to true operational audits. What was often sacrificed, however, was the auditor's role as internal "cop."

4. Reap the verification premium. A company's ethical and moral standards are established in the boardroom and the C-suite. The demise of high-fliers like Enron Corp. and WorldCom Inc. could have been prevented had those responsible had the proper respect for verification. Trust will be re-established in the financial markets when there is confidence in the verification of financial reporting.

That requires a return to constructive tension between the accounting firm and its clients, and a renewed commitment and value placed on the role of the internal audit function.

Stephen R. Scroggins and Gordon Grand 3rd are Managing Directors at Russell Reynolds Associates in New York. Grand leads the firms's Financial Officers Recruiting practice, and Scroggins is a manager in that group. They can be reached at 212.351.2000.
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Author:Grand, Gordon III
Publication:Financial Executive
Geographic Code:1USA
Date:Mar 1, 2003
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