The Sins of the Past

The anicent Romans had a tradition: whenever one of their engineers constructed an arch, as the capstone was hoisted into place, the engineer assumed accountability for his work in the most profound way possible: he stood under the arch.

Let it be clear at the outset that this post is not a free swipe at the world of actuaries.

Some of Honestly Lay Bare’s closest friends are actuaries and there is a very real chance that their beautiful 5 year old daughter will one day too see the world through the prism of life expectancy charts!

Having said that ... what was the American Association of Actuaries thinking.

About what you ask?

Probably easiest if we at this juncture plagiarise directly from a recent New York Times article.

**

The American Academy of Actuaries, the public face of a behind-the-scenes profession, is in disarray after quietly sacking its incoming president, then trying to conceal both his ouster and an unpleasant secret from his past.

The president-elect, Bruce Schobel, is one of America’s foremost authorities on the Social Security system. He is also a onetime convicted felon who, according to court records, served time three decades ago for “assault with a dangerous weapon while demanding property” in New Jersey. Few know this, though, because his record has been expunged.

Mr. Schobel has put many productive years between himself and his conviction. The matter would probably be entirely unknown if it had not surfaced in the profession’s long-running debate about actuarial accountability, and the way numbers bearing little resemblance to reality keep turning up at the scene of failed insurance companies, collapsed pension funds and states that cannot balance their budgets.

Such scenes are embarrassing to actuaries, who consider themselves crack risk-management experts, toiling in obscurity to keep insurance companies solvent and pensions funded. Like doctors, they are generally reluctant to point fingers in public or accuse a colleague of malpractice.

The profession, decentralized and largely unregulated, relies on public trust, and no one wants to undermine that trust. So when controversy flares, there are panels, discussions, resolutions — but often little change.

Mr. Schobel has been among those trying to modernize the profession, raising its profile in Washington and its credibility with the public. Now, though, he is turning into one of the problems it has so much difficulty solving.

A spokesman for the academy said he could not comment on any aspect of Mr. Schobel’s ouster.

Mr. Schobel, in response to questions, offered documents contending that his removal was illegal and letters he had received from both his sympathizers and his detractors. He said his opponents had tried to use unflattering and irrelevant information to blackmail him. Several of his supporters cited a New Jersey law making it illegal in that state to reveal the existence of an expunged criminal record.

It was Mr. Schobel, however, who revealed his criminal record, in open court in Cook County, Ill., two years ago.

He argued then, in a different lawsuit, that his crimes were “high misdemeanors,” not felonies, but the court disagreed and found that “felony” was the correct term. He was also convicted on a charge of “atrocious assault and battery” in that same episode.

The academy’s current troubles began in June, when 19 of its former presidents — nearly all of its former presidents living today — sent a letter to its board, saying that the public expected an “exceptionally high level of integrity” in actuaries, and expressing grave doubts about Mr. Schobel’s suitability as president. The board met in early August, and the majority voted to remove Mr. Schobel.

This was unprecedented — and yet no one broke the news to the membership. Only about three weeks later did the academy post a bland notice on its Web site, saying it would fill “the vacancy in the office of the president-elect,” without mentioning Mr. Schobel or explaining why there was a vacancy.

That started an uproar.

Angry and incredulous actuaries have besieged the academy, quoting from the Declaration of Independence, calling the board “drunk with power,” and demanding to know what had happened to Mr. Schobel. Some pointed out the academy’s weak governance structures and proposed a coup of sorts.

This month, Mr. Schobel sued the academy, saying it had defamed him and removed him illegally, after being intimidated by “a cabal of individuals who disagree” with his “vision for the academy, and his personal style.” The lawsuit, filed in United States District Court for the District of Columbia, seeks Mr. Schobel’s reinstatement, and $2 million in damages for defamation and harm to his client relationships.

It does not mention his conviction, but does refer cryptically to a blackmail attempt and to “certain events that occurred over 30 years ago.”

The academy has filed a response saying its board’s actions were legal and appropriate. It did not mention the felony conviction either, but attached further documentation under seal.

As it happens, the documentation is not sealed in the court in Cook County, where the academy is incorporated. There, Mr. Schobel was sued in his capacity as president of a sister group, the Society of Actuaries, in 2007.

The suit was filed by Sarah Sanford, who had been fired as executive director of the society and who accused Mr. Schobel of defaming her. In her complaint, she mentioned the long-running actuarial debate about accountability, adding that she had clashed with Mr. Schobel over whether convicted felons should be barred from the profession. She said she had supported such a ban, but Mr. Schobel had opposed it, saying felons should be barred only if their crimes were related to financial services.

Few knew at the time that Mr. Schobel had personal reasons for his stance. Ms. Sanford said she had found out about Mr. Schobel’s felony conviction, and then learned that he knew that she knew. Almost immediately, she said, he began telling people he was going to get rid of her, saying she had taken “kickbacks” and “looted the Society of Actuaries.”

Reached this week in Illinois, Ms. Sanford said she had nothing to say beyond the existing court records in the case.

A year and a half of messy litigation followed, in which Mr. Schobel countersued, accusing Ms. Sanford of defaming him by sending e-mail messages under a fake name, telling other actuaries about his old felony conviction.

In the end, an arbitration panel found that Mr. Schobel had been unable to provide any evidence to support his claims that Ms. Sanford “looted” the society — or that she sent defamatory messages about him. The society, a co-defendant with Mr. Schobel, had to pay an award and court costs of a little more than $2 million.

Mr. Schobel tried to have the records sealed, but a Cook County circuit judge refused, on the grounds that Ms. Sanford had been harmed and had the right to clear her name.

By that time, though, Mr. Schobel had become the president-elect of the American Academy of Actuaries, having been nominated and affirmed by its board. The board of the academy, based in Washington, was unaware of the legal debacle at the society, which is in Schaumberg, Ill., and Mr. Schobel had been the only nominee for the post.

“Defamation of character is unprofessional and does not uphold the honor of the office of president-elect of the American Academy of Actuaries,” one former president, David Hartman, wrote in a message to Mr. Schobel. Mr. Hartman said he could not fathom why Mr. Schobel had not tendered his resignation at once.

Mr. Schobel, who offered the note as explanation about the dispute, responded: “You only make yourself look foolish taking a position on a subject about which you know so very little.”

“The fact that the A.A.A. board crumbled in the face of an extortionist’s demands says something about the board’s principles — or lack thereof,” Mr. Schobel said in response to questions. “Fortunately, Illinois law protects me, the A.A.A.’s membership and the public in general.”

While he soldiers on in court, the academy has begun a search for a new president-elect. Whoever does emerge will be seated as president at a full meeting of the academy in Boston on Oct. 26.

**

But for the Grace of God!

Post based on Removal of Leader Stirs Anger Over Dealings of Actuary Group by Mary Williams Walsh New York Times September 8, 2009.

Wrong

Where facts are few, experts are many.

Today Honestly Lay Bare walks down the dark path of capital punishment to illustrate a major deficiency in the construction of the practice of internal audit.

It is a story of an Englishman – William Harrison and the summer of 1660 near the village of Charingworth in Gloucestershire.

In the August of that year, Harrison, estate manager to Baptist Hicks, set off on foot for Charingworth in order to collect rent owed to his master. However, as he had not returned by dusk, Harrison's wife, becoming worried for his safety, despatched Harrison's man servant, John Perry to look for him.

By daybreak, however, neither Harrison or his servant had returned. Getting increasingly distressed, Harrison's wife sent out her son, Edward Harrison, in the direction of Charingworth to enquire about his father's movements the previous night. On the way to Charingworth, Edward met John Perry, coming in the opposite direction. When questioned, John Perry told Edward that his master, William Harrison, was not there. So, together they went to the nearby village of Ebrington. At Ebrington, they were told by one of the tenants that Mr Harrison had called at his house the previous evening on his way back from Charingworth.

On their way back, they came to hear that a hat, shirt, collar and comb had been found on the main road between Ebrington and Campden, near a large bank of gorse. Finding the hat and comb slashed and the shirt collar covered in blood, they immediately started to search the area, assuming that Mr Harrison had been killed.

On returning to Campden, the news of this discovery caused great alarm; so much so, that the men, women and children of the town took it upon themselves to search for the body. Meanwhile, back at the Harrison's home, his already distressed wife now feared heavily for her husband's safety.

As Mr Harrison had been sent to collect rent money, many townsfolk started to suspect that John Perry had killed his master and stolen the money. Perry was brought before a Justice of the Peace, who questioned him about his master and why he had stayed out all night when sent to find him. Perry's version of events were that after his mistress had sent him to meet Mr Harrison, he headed towards Charingworth, where he met a man called William Reed. Reed asked him where he was going, to which he replied that he was going to Charingworth to find his master; but as it was now getting dark he was afraid to go on and was going to return to Campden and fetch a horse belonging to his master's son, Edward. He walked with Reed back to Campden, where Reed then left him at his master's gate.

From that point, Perry said that he entered his master's hen roost and had stopped there until the church clock had struck twelve o'clock. He then left the hen roost and walked back towards Charingworth, getting lost on the way due to heavy mist and ending up spending the rest of the night sleeping under a hedge.

The next morning, he proceeded onto Charingworth, where one of the tenants told him that Mr Harrison had been with him the previous afternoon collecting his rent, but did not stop long. Perry said that on leaving Charingworth, he then met his master's son, Edward, and had gone back to Ebrington and Paxford.

Perry was questioned further and then remanded in custody in Campden. Whilst in custody, Perry finally indicated that if he were taken before the Justice of the Peace again, he would disclose some new and vital information regarding his master's killer. On further interrogation, Perry stated that his master had been killed not by him, but by his brother and mother, who had robbed Harrison for the rent money. Perry's only involvement was to provide his mother and brother with the time and date that his master would be making his journey to Charingworth to collect the money.

Perry's mother and brother were also questioned, and then the three of them were tried and found guilty of killing William Harrison to obtain the rent money. A few days later, John, Richard and Joan Perry were taken to the top of Broadway Hill, which overlooks Chipping Campden, and hung for their supposed crimes.

The first person to be hung was Joan Perry as she was thought to be a witch and had placed a spell over her sons. Next to be hung was Richard Perry, who begged his brother John to tell the truth about the disappearance of William Harrison. But, John Perry stuck by his story and they were both duly hung.

**

And that would have been the end of the story and definitely not a story worthy of retelling nearly 400 years later but for one thing.

Two years later, Harrison reappeared.

He insisted, fancifully, that he had been abducted by a band of criminals and sold into slavery.

Whatever happened, one thing was indisputable: he had not been murdered by the Perrys.

And then ... as is the way of Honestly Lay Bare’s thinking ... our mind started to drift into the less salacious – but only marginally safer – world of internal audit.

Has an internal auditor ever – by direct intent or subconscious incompetence – seen someone accused of a control deficiency that has cost them their reputation or job (thankfully not their life!) in a situation that was not or could not be supported by the underlying facts.

And unfortunately we had to come to the answer in the positive.

Of course – somewhere in the world of internal audit either now or in the past – there have been times when it has suited the political agenda of the internal auditor to place undue weight on matters that would otherwise wither in the sunlight of full factual disclosure.

And herein lies a great flaw in the practice of internal audit – there is no effective and fair remedy to address such moments.

Of course an issue can be removed because of factual mistake – Honestly Lay Bare does that all the time.

Of course we can publish a rebuttal from Management to an issue that Management believes is not portrayed fairly.

Of course we can argue our case – as can Management – to the highest levels of corporate governance within our organisations.

What Internal Audit has never done and seems incapable of doing is introduce a dispassionate mechanism whereby all parties to an audit can agree that we are auditing a consistent interpretation of the underlying factual situation.

By definition, auditors bring to an audit their personal prejudices and see circumstances through the prism of their past experiences.

As such whilst internal audit can be independent of Management it can never be truly independent of mind.

Ka Boom

Retribution often means that we eventually do to ourselves what we have done unto others

On this the first anniversary of the start, explosion, crystallisation (depending on your take!) of the GFC, Honestly Lay Bare decided to don the lycra shorts and hop into the Tardis to a visit to a New York gym exactly one year ago last Sunday night.

Before we do, however, some context.

On September 15, 2008, Lehman Brothers filed for Chapter 11 bankruptcy protection following the massive exodus of most of its clients, drastic losses in its stock, and devaluation of its assets by credit rating agencies. The filing marked the largest bankruptcy in U.S. history.

The Chief Executive Officer of Lehman Brothers at the time of its collapse was Richard Fuld.

The business news cable network CNBC reported at the time:

“He went to the gym after ... Lehman was announced as going under.

He was on a treadmill with a heart monitor on.

Someone was in the corner, pumping iron and he walked over and he knocked him out cold.”

**

Only problem is that the story – as good as it sounds – isn’t true.

The (then) Lehman Brothers gym isn’t open on a Sunday – the day that the alleged incident occurred.

Here at Honestly Lay Bare we are never one to let facts get in the way of a good story though and the tale of the punch got us thinking.

What retribution does a diligent, hard working and honest employee have when they perceive that their bosses are not a mirror image?

We do not condone violence – primarily because we fight like a blind fish hailing a taxi.

Of course one could whistleblow – and there is most definitely a place for that as there should be.

But what if someone doesn’t want to go that route – what next?

Complain will get you so far but probably will just raise your anxiety levels if the person you are complaining to is the source of your original angst.

Resign perhaps?

Honestly Lay Bare has always held the view that a good internal auditor is one that has their resignation signed in their top pocket for this very reason.

In the Lehman case – that option went out the door as soon as the Chapter 11 was signed off.

Hence the reason we guess that everyone was so keen to believe the Fuld Decked by an Aggrieved Employee story!

We are, in the end, humans seeking retribution when we perceived that we are wronged.

For the simple minds of Honestly Lay Bare, therein lies the GFC story for the ages!

Schlimmbesserung

It is a mistake to think you can solve any major problems just with potatoes.

Today, Honestly Lay Bare introduces into the lexicon of internal controls a concept that we dare not speak its name (primarily because we cannot pronounce it ... but that is another story).

From this day forward throughout the many lands and fields in which the management of risk is attempted we ask that you pray at the feet of the God of Schlimmbesserung.

For if the God of Schlimmbesserung is kind – you will probably get to keep your job and actually make a difference to the success or otherwise of your organisation and / or economy.

If the God of Schlimmbesserung is spiteful – well, at least you know that you tried your best and ... it wasn’t up to scratch.

What is / who is / where is the God of Schlimmbesserung?

Well let’s start by answering what is schlimmbesserung.

Firstly it is a real word.

We promise.

It is a German word for ... well ... how does one actually say this ... for stuffing up!

To be precise it is making something worse through an attempt to make things better.

And here at Honestly Lay Bare that got us thinking.

When has the God of Making Something Worse Through An Attempt To Make Things Better ... better known as the God of Schlimmbesserung ... paid a visit to the world of internal controls?

We came down to one day.

That day – Tuesday 30th July, 2002.

Yes Honestly Lay Bare is calling out the day that the Public Company Accounting Reform and Investor Protection Act of 2002 (of course we are referring to Sarbanes Oxley!) was introduced as The Day that the God of Schlimmbesserung said hello to the world of internal controls.

The Act was approved by the United States House of Representatives by a vote of 334-90 and by the Senate 99-0. President George W. Bush signed it into law, stating it included "the most far-reaching reforms of American business practices since the time of Franklin D. Roosevelt."

In a 2004 interview, Senator Paul Sarbanes stated: “The Senate Banking Committee undertook a series of hearings on the problems in the markets that had led to a loss of hundreds and hundreds of billions, indeed trillions of dollars in market value. The hearings set out to lay the foundation for legislation. We scheduled 10 hearings over a six-week period, during which we brought in some of the best people in the country to testify...The hearings produced remarkable consensus on the nature of the problems: inadequate oversight of accountants, lack of auditor independence, weak corporate governance procedures, stock analysts' conflict of interests, inadequate disclosure provisions, and grossly inadequate funding of the Securities and Exchange Commission.”

The God of Schlimmbesserung doesn’t care that you had good intentions.

It is how it ended up that counts.

A December 21, 2008 Wall St. Journal editorial stated, "The new laws and regulations have neither prevented frauds nor instituted fairness. But they have managed to kill the creation of new public companies in the U.S., cripple the venture capital business, and damage entrepreneurship. According to the National Venture Capital Association, in all of 2008 there have been just six companies that have gone public. Compare that with 269 IPOs in 1999, 272 in 1996, and 365 in 1986."

The editorial concludes that: "For all of this, we can first thank Sarbanes-Oxley. Cooked up in the wake of accounting scandals earlier this decade, it has essentially killed the creation of new public companies in America, hamstrung the NYSE and Nasdaq (while making the London Stock Exchange rich), and cost U.S. industry more than $200 billion by some estimates."

And for that price tag, can anyone of us say that things – as in the soundness of corporate control frameworks – have measurably improved by the introduction of Sarbanes Oxley.

How does one explain then the ‘failure’ of Sarbanes Oxley to play a role – any role – in the identification, prevention and or mitigation of say something like ... hmmm ...the global financial crisis.

Where were you Sarbanes Oxley when the sky was falling in and the world – literally – was looking for assurance that we weren’t going to go into the world’s worst depression?

Schlimmbesserung.

Indeed.

Sonya's Adventures

Fraud and falsehood only dread examination. Truth invites it.

As long term – come to think of it even short term – readers of Honestly Lay Bare will attest – we love a good fraud story.

One recent Australian fraud caught our attention ... not so much for the facts of the case but for the response of the company that was the victim of the fraud.

Lets start with the facts of the case and then make your mind up as to whether you think that the post fraud publicity was handled well.

**

The payroll manager of whitegoods and electrical retailer Clive Peeters has admitted she used $20 million in company funds on a spending spree, buying more than 40 properties in the past 18 months.

Sonya Causer spent the equivalent of a year's company earnings secretly compiling an impressive portfolio.

In total she bought 43 properties.

Her 18-month spree from the listed retailer - which has 49 stores and 1300 staff - was worth more than the pre-tax earnings of $17.3 million in the 2008 financial year.

She also spent $166,500 on three cars, including a luxury $105,000 Audi four-wheel-drive, a Holden station wagon and a Toyota LandCruiser.

But last month her double life came crashing down, when she was confronted by managing director Greg Smith and she admitted to using a loophole in the company's internet banking with National Australia Bank to steal from the company.

''I have stuffed up big time and just want to curl up in a ball and disappear,'' she told Mr Smith in one of their meetings.

Mr Smith said he was hopeful the company would be able to recoup most of the losses because Ms Causer had confessed she had stolen the funds and agreed to transfer the Victorian properties back to the company. Many of the homes had been generating rental income, he said.

Ms Causer has admitted to falsifying payroll records, transferring cash to her bank account.

Until the full scale of the fraud was uncovered by auditors , Ms Causer, who has worked at the Clive Peeters Melbourne head office for three years, tried to cover up and then play down her role.

She was able to transfer company money to her bank account, and those of her company, M & S Business Enterprises, between November 2007 and June this year because she was a signatory to the company's account, as a senior member of the finance team. Her theft was not immediately apparent because she attempted to cover her trail by changing financial records.

Ms Causer started snapping up her portfolio just seven months after she was promoted to payroll manager in April 2007.

The alarm was raised on the missing money on July 29 when one of her colleagues, another Clive Peeters accountant, noticed a $2 million variation between two company ledgers. Only after further investigation by the auditors did the company discover there was a much larger hole.

The company told the Australian Securities Exchange at the end of July that it had found an unexplained $7 million hole in its accounts. This later grew to $20 million.

Ms Causer initially purported to assist the company's auditors, Deloitte, in the investigation of her own fraud.

Only after she attempted to cover her money trail by changing figures on internal accounting systems did she admit to management she had falsified financial documents.

Ms Causer initially claimed she had only falsified entries in an accounting ledger to ''help the company'', only later confessing to the full extent of the theft in a meeting with Mr Smith on August 4.

As payroll manager, Ms Causer had a salary of $125,000.

**

As frauds go – that is relatively run of the mill.

What Clive Peeters did next isn’t so run of the mill.

In most major Australian newspapers yesterday, Clive Peeters took out a full page advertisement as an open letter to its customers.

In essence it was an advertisement both for their new product range AND the fraud that had been committed against it.

In the advertisement it said “in the last few weeks we have weathered an unexpected storm – the misappropriation of Company funds by an employee”.

That line got Honestly Lay Bare thinking.

Why would you advertise that you have had a fraud?

What is the benefit to the organisation to tell the world that you have sufficiently lax internal controls that a whole year’s profit could be put into jeopardy.

Those of your stakeholders who cared about the fraud (ie – investors seeking the highest return) would already be aware of it.

Those of your stakeholders who couldn’t care less about the fraud (ie – customers seeking the lowest price) would benefit how from being made aware about it now?

Some things are beyond Honestly Lay Bare’s comphrension.

PS – Yes the photo above is Sonya Causer. She sits proudly in the Holden SportWagon she successfully bid for in the Royal Children's Hospital Good Friday Appeal Online Auction last year – with Clive Peeters money!

Post based in part on “Clive Peeters left reeling by $20m sting” The Age August 12th 2009