Economic Crisis – Auditors Evolving Role IAA Charlotte March Michael P. Cangemi CPA, CISA Former CAE - CEO Etienne Aigner & FEI Advisory Board Member – FASB, COSO Management, IT, Financial Governance 1 Cangemi Company, LLC

Business Career Merrill Lynch/Blair&Co – High School&College Ernst & Young – CPA – Dir IT Audit Phelps Dodge – CAE – VP - CIO Professional work – IS Control Journal (87- 07) & Books - Managing the Audit (Wiley) BDO Seidman Ptr. IT Audit – IA Services CFO/COO to CEO Etienne Aigner, Inc CEO Financial Executives Intl Advisory Boards – FASB; Pace Univ.; private companies; Rutgers CA/CM – fmr COSO Management, IT, Financial Governance 2 Cangemi Company, LLC

Leverage infused Credit Crisis Lehman Brothers – wiped out Bear, Merrill, Wachovia – merged 200+ banks taken over by FDIC 32-1 leverage – more on this risk later AIG- regulated company – Gov take over GM- non -regulated – Gov take over " Greenspan said, "We are in the middle of a once-in-a-century credit tsunami."

Today’s Goals: Managements Prospective 1. Crisis – impact on your business Recession puts pressure on costs – even audit and recently IT spending; efficiencies from IT have been #1 cost reduction driver 2. What else auditors should be doing! 3. Fraud risk always present: rises in downturns – but always present!

Credit Crisis - Primer Recent History What caused this Credit Crisis Easy Monetary Policy And A simple financial instrument

Sub-Prime Malfeasance A mortgage was a safe loan Securitizations -Packaged into Mortgage Backed Bonds – Fee income for IB Packages of Mort-Backed Bonds into Collateralized Debt Obligations (CDO) Good collateral – until no money down, interest only, credit scores don’t matter House prices declined = crash!!!

Roots of a problem Community Reinvestment Act Born in the Carter Administration Praised by Bush- Clinton- Bush Ordered banks to extend loans to minorities; lead to more loans Fannie & Freddie offered to securitize the loans – Congress expanding home ownership!!!

If not Bad Guys – Fee Income is gone Management, IT, Financial Governance 8 Cangemi Company, LLC

Market Cycles 101

Blame game Lax Credit criteria – system of moving risk to others – after taking fees Unregulated mortgage brokers Add 2% and 20% --- leverage Lack of adequate regulation –CDO’s Soft regulation on Short selling Rating Agencies – big issues!!

Fair Value Accounting Not the problem – always used LCM FASB-IASB issued guidance in reaction SEC reviewed Fair Value Accounting Jan 09 FASB issued guidance on valuations 157e Determine when a market is Not Active 115a Other than Temporary Impairment BIGGER ISSUE is sovereignty and regulatory oversight of accounting under IFRS

Wall Street & Derivatives- CDOs What are credit default swaps – insurance – maybe or bets – shorts and longs – weak regulation (Bucket Shops – Jesse Livermore) New Regulations coming –BIG Changes mandate oversight over the credit default swaps market & more regulation of short sales

New Regulations – Federal reserve gains regulatory power over “too big to fail” institutions Financial Services Oversight Council Addresses gaps in regulation Consumer Financial Protection Agency new rules over credit cards, mortgages and other consumer products

Three selected Mega Trends 1. Sever recession – credit contraction 2. Globalization - Competition Rise of Elephant & Dragon; Brazil etc. Expansion of Global Capital Markets - Global Shift: 2003 US was 44% % 3. Audit costs basically doubled – but recently rationalization of SOX costs

What is in our post crisis future? A slow economy – recession or “Great” Initially major impact from drop in capital markets - losses of 401K Market has come back – avoided crash Management Perspective -much higher unemployment Lower consumer spending – lower USA - GDP

New Playing Field Eco Crisis leads to BIG changes – GM Bond holders lose to employees Gov takes equity and management decisions Fed - systemic risk regulator; SEC-PCAOB? New consumer regulator

What will be the “New Normal” High levels of Government Debt Very large Government – new regulations Inflation – around the corner Higher taxes & Savings= lower consumer spending –on goods and services Continued difficult business environment What are you changing? Management, IT, Financial Governance 18 Cangemi Company, LLC

React to the New Normal US will be less of an economic power Maybe US $ replaced by a basket More outsourcing – to lower cost countries – accounting, audit & IT Difficult Business environment – should lead to innovation – lots of changes

New Normal – Audit –IT Audit Get in the flow with management My Book: Periodic Audit Mgt Change Innovate/Reinvent - Respond Larger focus on formal ERM - GRC To Do- Lower cost – higher imagination COSO Continuous Audit & Monitoring Discuss further greater coverage lower cost! Outsourcing audit – Global

ERM - Banks measure credit risks – programs based on underlying financial strength ratings and probabilities In non-financial there are many different business risks – boards address on an ongoing basis; not as obvious All subject to management override

Audit Involvement in ERM Basically a good thing – to a degree BUT – What is ERM and note it works until management overrides Leman; Merrill; Bear – had risk models Trying to apply Fin Company risk model My advice: Set your Audit Charter realistically

Leverage – 1929 in a new form 32 to 1 – are you kidding!! Say you raise $10,000,000 Now investing $320,000,000 - OPM Earn 2% Fee = $6.4 M vs. $10 M raised Did IA have a risk comment – ERM ?? Buffet’s comments in DC : 2% & 20% rule

COSO - ERM page 3 -“ERM enables management to effective deal with uncertainty.” Page 5 - Achievements of strategic objectives and operations, however, is subject to external events not always within the entity’s control Page 13 - All entities face uncertainty the challenge is for management - how much uncertainty is it prepared to accept? Question – how do you determine how much of an unknown you are prepared to accept.

IA Adding Value ROI Challenges Not producing products or revenues!! How do you contribute more to the business? Set IA Charter High – Improve control; E&E of ops and positive deliverables IA – People, Procedures – Reports Take advantage of automation

IA Adding Value – ROI Use of Technology – different solutions by sizes of company Continue to expand use of automation for administration and audit testing Use leverage – recommend built in CM controls testing to business units; help them implement

COSO Cube Recognized as the major framework for evaluating internal control Opportunity to build in controls; save money; increase coverage; find errors; recover $$$

New Normal for Audit - Monitoring - Make Audit efficient A means to control efficiency and effectiveness. “Management should be able to rely on self-assessment and, more generally, the monitoring component of internal control, provided the monitoring component is properly designed and operates effectively” (PCAOB, AS5, P. 5)

Concepts of Monitoring

New Generation – CM Software ACL; IDEA; Approva & Oversight Oversight Systems No business process works perfectly. The sooner an error is identified and corrected the better. Oversight's advanced analytics inspect each step in every transaction in a financial business process to identify fraud, misuse and error.-- Oversight Systems

New Normal - Oversight’s continuous auditing solution built-in report and dashboard features that present continuous risk reports with color-coded risk ratings (i.e., red, yellow, and green) for all key control objectives. threshold-oriented reports automatically alert audit professionals

Audit Dash boards

© 2007 Oversight Systems33 Click-through to Relevant Exceptions

© 2007 Oversight Systems34 Plain Language Exception Descriptions

New Normal -Lower Audit Costs Costs - SOX caused audit cost to increase Now is the time to rationalize, make the control structure more efficient CCM is an answer to expanded ERM EDPACS Article – case studies Fraud – everyone now tuned in to possible fraud – thanks to Bernie et al – CCM – it will continue!!!

Financial Scandals & Markets Financial Scandals are not a new phenomena Management, IT, Financial Governance 36 Cangemi Company, LLC

Recent Financial Market Crises 1980s Saving & Loan Bailout 1987 Market drop and rapid recovery 1998 Long-Term Capital failure & fallout – terrorist attacks accounting scandals and bankruptcy's –some caused by bad guys sub-prime induced dislocation- some again caused by bad guys

Discovery of America – New Land Schemes Management, IT, Financial Governance 38 Cangemi Company, LLC

Madness of Crowds The Tulip Bulbs Bubble 1600’s – emotional market ?? South Seas & Mississippi Companies – UK investors bet on America Rail Roads Bubble 1990’s Internet Bubble 2000’s corporate frauds leads to SOX! Management, IT, Financial Governance 39 Cangemi Company, LLC

Bad Guys circa Global Société Générale – one trader $7.2 billion loss Bernie Madoff – never bought a security Texas financier R. Allen Stanford -sold CDs in US kept the cash –Global Fraud! Venezuela "seized a failed bank controlled by Stanford after a run on deposits” UBS Off Shore Accounts Investigation

Closing Thoughts Audit is a business – must be efficient Business run on cash Try for cash recoveries Lower expenses Careful expanded focus on GRC- ERM Be creative – innovate – high imagination low cost solutions – use automation Think Globally Management, IT, Financial Governance 41 Cangemi Company, LLC

Questions? Management, IT, Financial Governance 42 Cangemi Company, LLC

Cangemi Company LLC Senior Advisor & Board Member Consulting –Financial, Strategic & Governance, Internal Audit Media -speaking; teaching Book -Managing the Audit Function; available at Amazon, Wiley and other book sellers Management, IT, Financial Governance 43 Cangemi Company, LLC