THREATS TO AUDIT OBJECTIVITY – AND HOW TO MANAGE THEM

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There are myriad threats to audit objectivity – from corporate pressure to office politics. How can you effectively manage these? In this article, independent consultant, speaker and author Steve Giles explores the options.

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Extraordinary Circumstances: The Journey of a Corporate Whistleblower is the account by Cynthia Cooper, the ex-vice president of internal audit for WorldCom, of the discovery and investigation by her team of large-scale financial statement fraud perpetrated by senior executives.

It reads more like a John Grisham thriller than a book about internal auditing. It is a story about courage: sticking to professional standards despite fears for personal safety: refusing to be deflected by management obstruction or requests for delay; working late at night and behind closed doors; coping with everyday stress, such as confrontations in the canteen or difficult phone calls when at the hairdressers.  Ultimately, it is a story about blowing the whistle on one of the largest accounting frauds in history.

Times have changed – WorldCom filed for bankruptcy in 2002 following the exposure of the $11bn fraud. Governance and auditing standards are now more robust and – learning the lessons of the financial crisis – there is a sharper focus on corporate culture, conduct and business ethics. Is the background to Cooper’s story – one of widespread pressure from managers seeking to influence the work of internal auditors – still relevant today?

FRAUGHT WITH TENSION

The answer is a resounding ‘yes’. A recent report from the Institute of Internal Auditors –The Politics of Internal Auditing – reveals that internal audits are typically fraught with tension and that many auditors are working under inappropriate pressure. For example, managers will try to influence auditors into omitting or modifying conclusions that they regard as damaging or into ignoring high-risk areas of the operation. The report classifies this as political pressure, something that the authors describe as ‘extensive and pervasive’. It constitutes a threat to internal audit independence and objectivity.

This article reviews the main findings of the report and then considers the implications for internal auditors from two perspectives

  • from that of the advice provided in the report – around those situations where it is possible for internal auditors to navigate corporate politics successfully and while remaining influential and continuing to get their message across
  • from advice provided by ACCA – which helps internal auditors handle unusual and difficult situations where they are pressed to do something they consider unethical.

The report addresses political pressure on chief audit executives (CAEs) and their internal audit departments. It is based on a survey of almost 500 North American CAEs, together with interviews with heads of audit around the world and focus group sessions. The feedback shows CAEs coming under pressure in two significant areas: the scope of internal audit work and the wording of internal audit reports.

According to the research findings:

  • nearly 55% of the CAEs surveyed report being directed to omit or modify an important audit finding at least once (with 17% indicating this had happened to them three or more times). 71% of these note the pressure was due to a concern that the report would reflect badly on key operating management
  • 49% report being instructed not to perform audit work in a high-risk area, usually by an executive in the organisation
  • nearly 32% report being directed to work in low-risk areas so that an executive could investigate or retaliate against another individual
  • CAEs with impeccable service records in both the private and public sector lost their jobs or were encouraged to take other positions or early retirement for challenging management on political issues.

The report sets out the various forms of political pressure. Some are overt, including physical threats or threats of being fired, while others are more subtle, including cuts in internal audit staff and budgets. Most importantly, the research shows the extent to which heads of internal audit and their departments come under pressure from corporate management – not a commonplace event perhaps, but one that happens surprisingly often nevertheless.

MANAGING POLITICAL PRESSURE

Sometimes it is relatively easy to handle management interference. For example, it might be possible to resolve pressure in the form of an instruction to change an audit finding through a discussion between the head of internal audit and the executive concerned. Effective communication remains a key audit skill. Of course, such a discussion is made easier if the internal audit department has built up its relationships in advance and can explain why it matters to the organisation as a whole to report the finding accurately.

Not all political pressure is so straightforward to deal with and there will be governance implications if internal audit objectivity is compromised. It is vital therefore that audit committees are effective, that their members understand the issue of political pressure and make clear their support for an objective and properly resourced internal audit function.

The report states that political pressure always exists in organisations. It can be managed and mitigated (though never eliminated) if best practices are in place: a competent CAE; a sound internal audit function; a clear understanding of the business; conclusions based on factual evidence; and respectful relationships with executives and the board.

There are a number of lessons coming out of the research that internal auditors can learn from, including:

  • two of the most important factors in managing political pressure are building strong relationships and becoming outstanding communicators. An effective head of internal audit will develop trusted relationships with executives and members of the audit committee based on personal interaction. Effective communication will convey the results of internal audit work clearly and objectively. Combined, these factors give assurance that senior management and the board understand the role of internal audit and that its work must be objective in order to add value to the business
  • business acumen is required too and internal auditors need to demonstrate that they have a sound knowledge of the business and its strategies. The most effective CAEs convey audit findings from management’s perspective, rather than a narrower internal audit perspective
  • professional competence is essential if internal auditors are to handle the pressures of the job successfully. Feedback in the report emphasises the importance of thorough audit work and analysis, objective and accurate conclusions and an understanding of the effect of the audit findings on the organisation. If stakeholders have confidence in the quality of the audit work, this will help to resolve any disputes with the operational managers whose work is being audited
  • in addition to technical skills, internal auditors need to develop their emotional intelligence too. There is sometimes a fine line between inappropriate political pressure and disagreements arising from the different points of view taken by various stakeholders. From time to time senior executives are likely to dispute audit findings or express displeasure at the scope of an audit. Working through such difficult situations comes with the job. Internal auditors need to be politically astute and sensitive to the organisation’s culture in order to navigate this type of pressure.

ETHICAL DILEMMAS

Internal auditing involves making judgment calls and in some situations there is no straightforward resolution. It may be easy to rationalise under pressure but this can be dangerous, especially if it results in compromises over objectivity and honesty – personal reputation can be lost very quickly. One important point in the IIA’s report is that internal auditors should identify the circumstances where they need to stand their ground. A key question is how should they respond when asked to do something that they consider to be unethical or in breach of their standards?

One option is to blow the whistle. The CAEs interviewed in the report preferred to go through internal channels rather than to inform the authorities. What they really wanted was effective governance in their organisation, not exposure in the press or third party investigations. So, the quality of whistleblowing hotlines is crucial here.

FUNDAMENTAL PRINCIPLES

The primary reference point for internal auditors confronted by an ethical dilemma is the appropriate code of professional conduct. For ACCA members this is the ACCA Code of Ethics and Conduct.

The Code sets out five fundamental principles, with which compliance is mandatory:

  • integrity
  • objectivity
  • professional competence and due care
  • confidentiality
  • professional behaviour.

It considers the application of these principles within a conceptual framework which acknowledges that the principles may be threatened by a broad range of circumstances, thereby assisting members to identify, evaluate and respond to them.  One of the threats identified is intimidation – particularly relevant here – described as when a professional accountant is deterred from acting objectively because of actual or perceived pressures, including attempts to exercise undue influence over him or her.

Identified threats must be eliminated or reduced to an acceptable level so that compliance with the fundamental principles is not compromised. Where this is not possible, the guidance in the Code is clear: the accountant must decline or discontinue the service involved or resign from the engagement or the employing organisation.

Unfortunately, sometimes internal auditors have to be prepared to leave their position if their professional ethics are being compromised or disregarded. Courage is required in these situations.

Cynthia Cooper’s conclusion at the end of her book about the WorldCom saga provides essential and cautionary guidance for internal auditors today: ‘In many ways this story is about human nature, about people and choices. It shows how power and money can change people and how easy it is to rationalise, give in to fear and cave under pressure and intimidation.’

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