A good CFO is worth their weight in gold when it comes to determining whether their business is accurately and concisely reporting its financial information. Even more so, when they act as an effective conduit to safeguarding the board members who sign off on external financial reports.
In the aftermath of the Enron and WorldCom accounting and fraud scandals in 2000, the public have become sceptical of whether large businesses are manipulating their financial performance by applying unrealistic estimations and judgements to support asset valuations, inflate revenues or reduce expenses using reserves and provisions.
In an article published in The Irish Times in January 2016, former Enron CFO, Andrew Fastow, discussed how easy it can be to commit fraud if no one questions the balance sheet. Andrew went on to explain that every single deal he did at Enron was approved by the accountants at Enron, the external auditors, its own attorneys, the outside attorneys and the board of directors. As a result, he was able to conceal years of massive losses.
In a case of non-deliberate errors in accounting, a lawsuit brought against the directors for Centro Properties Group in 2011 became a lesson in educating the boardroom and senior financial experts on the classification of legal liabilities and the obligations they have when signing off on their external financial reports.
In what ultimately became a high profile and tangled disagreement between Centro and its auditors PwC, at the core of the case against the Centro directors was not that they knowingly misclassified $2 billion of short-term debt and failed to disclose a US $1.75 billion of guarantees of an associated company’s short-term borrowings given post balance date, but that they should have known the disclosures in the balance sheet were inaccurate.
Centro’s directors argued they were ‘entitled’ to rely on the specialist knowledge and advice from the company’s in-house accountants and PwC. They were assured the accounts complied with accounting standards and even after the error was detected, it wasn’t brought to the board’s attention before they approved the financial report for the 2007 financial year.
The judge who presided over the case determined that despite the non-disclosure of the short term debt and post-balance date guarantees entered into by Centro, these should have been well known to the directors and they were responsible for questioning each of these matters.
Reduce their risk
While the Centro case does read like a catalogue of errors and significant oversights, it puts a spotlight on the issue of how to minimise the risk of omissions and in-completeness of external financial reporting.
It also questions when a director can rely on the technical expertise of professional specialists, particularly in the absence of a qualified accounting or legal background, and when they should exercise their own good judgement.
Do we really expect all directors to have to second-guess their own experts every time a financial report is due or whether they should see their role as that of devil’s advocate and regard every piece of information provided to them as suspect? Can a board effectively function in this way and is it reasonable to impose those kinds of obligations on non-executives – people who, by definition, are part-time supervisors of management?
While the rational answer to this is no, it does highlight the danger of boards relying too heavily on management or auditors and that each member of the board must apply their own skills and knowledge when declaring that the financial report presents a true and fair view of the financial performance and position of the business.
Senior management, just like any of us, they can make mistakes. Of course, most of these are not deceptive by nature, but when companies like Enron, WorldCom or Centro fail, it is the individuals at the top who hold a significant share of responsibility who must take the stand (or the fall).
This is where a proactive and trustworthy CFO is invaluable in determining where the level of understanding lies between the board of directors of a company and management and the board’s ability to know what they should know when putting their signature on external financial reports.
The CFO can add unique value to the board by:
- Acting as a protection barrier. Reputational damage following the financial failure of a company is a stigma that is difficult to shake and has the ability to destroy careers. At the highest of levels, a CFO can be the protection barrier to avoid this occurring, while at a practical level they ensure the business’ financial matters are accurately and completely reported and managed by an experienced finance team.
- Engaging in accounting issues early. While strategic executives and legal consultants may design the commercial and legal agreements to achieve their corporate goals, how to account for the decisions is often left until too late. Addressing the accounting outcomes with the finance team and auditors before signing agreements can help to avoid any unfavourable outcomes.
- Building trust and providing stewardship. A CFO should treat their role with the same care as a director. They should take the initiative to ensure board members understand their role and duties and recognise the degree of care and diligence required of them by the Corporations Act to issue external financial reports which can be relied upon.
Cultivating an effective relationship between a board and its CFO requires leadership, trust, expertise and effort from the collective group, but it provides an assurance which can be relied upon by all stakeholders in the business.