As reported in Monday's Chicago Tribune, the SEC charged three ex-directors who served on DHB Industries Inc.'s audit committee for being "willfully blind to numerous red flags" of fraud. Just last year, the SEC accepted a settlement that included a $50,000 fine and a restriction against serving as a director or officer for five years from an audit committee chairperson, stating that the director failed to adequately investigate allegations on inappropriate related-party transactions. The SEC has made it clear that it will hold directors accountable for fraud deterrence. So, what can board directors do?
- Leverage internal audit or hire a consultant. Be sure your advisors remain outside the reporting lines of CEOs and CFOs.
- Implement a fraud risk management program to proactively address emergent threats to your organization. Sadly, only half of organizations have formal board risk oversight of fraud deterrence (2010 COSO Report).
- Know the business. Look for complex transactions that are more form than substance.
- Support fraud deterrence by continuous monitoring, surprise audits, segregation of duties, hotlines and ethics training.
- Address the Audit Report Expectation Gap. Revenue recognition, estimates, disclosures, related party transactions are areas most vulnerable to manipulation.
- Ensure auditor independence. Let your auditors know that you want the unvarnished truth.
- Watch out for management influence over financial reporting and their ability to override controls.
Fraud deterrence is a game of endurance. By following the steps listed above, directors will be well on their way to addressing their fiduciary responsibilities effectively and efficiently.
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