Both the design of compliance programs and expectations for their suc- cess need to take account of the environment in which companies are working. This chapter looks at three key features of the environment: the adequacy of internal control practices and standards in the area of accounting and auditing; the prevailing standards of corporate gover- nance; and the business culture, which in East Asia is influenced by the traditional practice of guanxi.
behavior appear to be at the root of the scandals. But it was the collapse of the control environment, including the compliance system, that made possible the development of conflict of interest and of ultimately self- dealing and improper transactions (box 5.1).
The U.S. Sarbanes-Oxley Act of 2002, which was enacted in response to the series of corporate failures, underscores the importance of tools such as codes of ethics and financial control frameworks. The SEC comments refer explicitly to the scheme control framework developed by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and described in box 5.2. This legislative and regulatory attention will
Box 5.1. Enron: A Syllabus of Errors
The Enron scandal may be the most compelling business ethics failure in a generation. The bankruptcy case that broke in late 2001 is still under investigation, but the scandal has triggered a major reassess- ment of corporate governance and accounting-related regulations.
Most of the public debate focused on the quality of disclosure and the role of accountants and Wall Street analysts. Although a number of facts have yet to be determined in court, it is acknowledged that mis- leading financial statements had to be amended when the facts could no longer be hidden. Particularly shocking on ethical grounds was the fact that high-level executives were selling their Enron stock while sending reassuring e-mail messages to employees whose retirement plans relied 60 percent on company stock.
Misguided corporate social responsibility and corporate gift-giving policies resulted in so many beneficiaries of Enron’s generosity that it was difficult to find directors who were free from the appearance of conflict of interest. For instance, William C. Powers, dean of the Uni- versity of Texas Law School, which received US$252,000 in donations, was chair of a special committee to examine transactions between Enron and its partnerships—transactions that were at the core of Enron’s problems. Unfortunately, such potential conflicts may not be unusual.
Company officers did not adhere to Enron’s code of ethics. Twice, the Enron board “waived” the company’s ethics code requirements to allow the chief financial officer to serve as general partner for the part- nerships that ENRON was using as a conduit for much of its business.
Rather than sell their stock on the market, some managers tendered their shares to the company. In so doing, they deferred considerably the date on which the sale would have been disclosed.
Source: Berenbeim 2002.
Box 5.2. The Importance of the Control Environment: The COSO Internal Control Integrated Framework
The Committee of Sponsoring Organizations of the Treadway Com- mission (COSO) was established by the accounting profession and by professional bodies such as the American Institute of Certified Public Accountants (AICPA). In 1992 COSO proposed a framework for internal control that had been prepared by professional bodies from the accounting and auditing profession in the United States. Accord- ing to COSO,
the control environment provides an atmosphere in which people conduct their activities and carry out their responsibilities. It serves as the foun- dation for the other components. Within this environment, management assesses risks to the achievement of specified objectives. Control activities are implemented to help ensure that management directives to address the risks are carried out. Meanwhile, relevant information is captured and communicated throughout the organization. The entire process is moni- tored and modified as conditions warrant.
© 2003 COSO.
The COSO framework, a reference for the internal audit, is conceptually very close to the compliance system detailed in chapter 4. In practice there are many synergies between the two: the internal audit is usually involved in the implementation of the compliance program.
Source: COSO, <www.coso.org>; AICPA, <www.AICPA.org>.
undoubtedly reinforce the role of internal financial control worldwide and of the COSO “cube” as the reference.
Roderick Hills, a former SEC chairman, notes that “in the war against corruption we need armies, and the one readily available, already at the frontline, is the accounting profession.” Proper discipline, professional
ethics, and capacities are required. In East Asia and in other emerging economies, financial crises and scandals show that there is much to be done. This has become a high-priority area for the reform of the financial and corporate infrastructure. Reforms rely, on the one hand, on the adop- tion of international standards and, on the other hand, on the strengthen- ing and capacity building of the accounting profession. In most countries the availability and quality of accountants proves to be the stronger con- straint on the implementation of sound practices.
In recognition of the link between public and private sector gover- nance, several countries have gone a step farther and have used the development of internal controls in the private sector to support an anticorruption drive at the national level.1 In Italy, for example, the anticorruption drive, “Mani Pulite” (“Clean Hands”), pushed for bet- ter corporate governance with a focus on transparency and disclosure and on internal company systems. Mandatory requirements were included in the Legge Draghi/Codice di Autodisciplina legislation of 1994.2
Korea has followed a similar path. An anticorruption act passed in 2001 stresses the responsibilities of all components of society, and article 5 states, “Private enterprise shall establish a sound order of trade as well as business ethics, and take steps necessary to prevent any corruption.” This reflects an ongoing trend in the Korean private sector, led by the Federa- tion of Korean Industries, to improve corporate governance (see box 6.2 in chapter 6).
Since the Asian financial crisis of 1997, Korea, Malaysia, and Thailand have taken steps to bring their accounting standards into line with those set by the International Accounting Standards Board (see box 5.3). A key target of those reforms is the accounting profession, which is compara- tively underdeveloped in East Asia both in quantity and in quality. Over- sight mechanisms have been reviewed and implemented by strengthening professional accountancy bodies (as in Thailand), introduc- ing regulations, and improving the enforcement of the regulations (Nabi and Nowroozi 2002).3