Chandra J outlines essential reforms in pursuit of good governance

Chandra Jayaratne

• The need to enhance statutory compliance commitments of auditors, directors and bankers

25 October 2015

An Open Letter to;

1.    The President and the Council of the Institute of Chartered Accountants of Sri Lanka

2.    The Chairpersons of the Chambers of Commerce and Industry

3.    The Chair Person and the Council of the Sri Lanka Institute of Directors

4.    The Chairman and Directors of Sri Lanka Banks Association

5.    The Director, Financial Intelligence Unit of Sri Lanka

6.    Chairman and Directors of the Sri Lanka Accounting and Auditing Standards Monitoring Board

7.    The Registrar of Companies

8.    The Chairman and the Board of the Securities Exchange Commission of Sri Lanka

9.    The Chairman and the Board of the Colombo Stock Exchange

 

Essential reforms in pursuit of good governance – The need to enhance statutory compliance commitments of auditors, directors and bankers

This open letter is addressed to you, as leaders of public and professional institutions committed to promoting good governance and statutory compliance by Auditors, Directors and Bankers, with the intent of seeking your collective leadership strategic initiatives, in pursuit of such goals by addressing some critical areas of weakness observed in the current control and compliance environment.

 

‘Fit and proper persons’ declarations

It is recommended that all directors, officers and top management members of companies, as a part of their statutory compliance commitments be required to annually to declare and affirm by way of a sworn affidavit placed before the board of the company, that they have, individually and collectively, engaged throughout the year in managing the affairs of the entity and its resources, acting at all times in the interests of the all stakeholders of the entity, and that they individually and collectively

•  Are ‘fit and proper persons’ 
•  Have duly discharged their duties and obligations as directors and officers with diligence, care and professionalism
•  Have acted within the applicable laws, regulation and accepted best business practice benchmarks of the sector
•  Have exercised their judgment and decision making without any bias 
•  Have maintained the confidentiality of information received in the performance of their duties
•  Have not used client and other privileged information for personal, family or third party gain
•  Have not at any time acted in conflict of interests and have duly declared all potential conflicts and all related party transactions
•  Have adhered at all times to business standards and ethics of the entity
•  Have not knowingly acted in any manner enhancing the risks of the entity and its stakeholders 
•  Have not knowingly at any time acted in any manner prejudicial to the interests of the stakeholders 
•  Have not directly or indirectly been associated with giving or taking bribes nor engaged in any acts of bribery and/or corruption
•  Ensured transparent public disclosures as required by statutory and regulatory requirements; accounts and related information as published reflect a true and fair view of the state of affairs of the entity and the entity is a going concern, with fair value disclosures with necessary impairment adjustments

The report of the directors or the governance report forming a part of the annual report, to confirm due compliance with above requirement by the directors, officers and the top management of the entity.

 

Avoidance of conflicts of interests

It is recommended that following a collective review of the current governance environment , you take steps to eliminate any weaknesses in the control and compliance framework linked to potential conflicts of interests of directors, auditors and bankers, especially in regard to the following;

• Persons acting as directors of banks and companies, whilst being engaged as auditors or directors of other entities, especially entities competing in the same industry/sector
• The strengths and weaknesses of the purported ‘Chinese Walls’ separating partners and officers of audit firms in under taking audits of entities competing in the same industry/sector
• Auditors indirectly engaging in providing corporate secretarial services through entities effectively managed and controlled by them
• Auditors indirectly engaging in providing to the companies audited by them accounting and other staff services through entities effectively managed and controlled by them
• Auditors directly or indirectly engaging in providing internal audit services and payroll services to the companies audited by them, using entities effectively managed and controlled by them
• Auditors directly or indirectly engaging in providing consultancy and advisory services to the companies audited by them ,especially in compiling marketing oriented reports and valuation services e.g. Prospectus for share/debenture issues, mergers acquisitions, etc.
• The failure to declare comprehensively and accurately all fee based service income derived by the auditors in addition to the declared audit fees
• The level of fees received by auditors itself exerting some degree of pressure and potential conflicts in regard to the independence of judgment and accuracy and degree of stress/highlights in the comments and exceptions which are embodied within published audit reports and detailed management letters.

Independence, integrity and operation of audit committees 

It is recommended that you collectively review, the current governance environment, independence and integrity of operations of audit committees and take such steps as to eliminate any weaknesses in these committees effectively discharging the role and accountability expected of them and especially examine whether;

1.    The audit committees, without the presence of the executive directors and officers of the company, should be requested to inquire from the auditors, at least at the time of accepting the annual audit certificate and probe where necessary, whether

a.They have received all information and records deemed necessary for the purposes of the audit and whether any such records or information they have requested have been denied by the executive directors, officers and management?;

b.They have in the conduct of the audit or in the exercise of their judgment their independence and professional review processes have been impeded in any manner by the executive directors, officers and top management and / or whether they have during the conduct of the audit been under pressure or persuasion to avoid some areas of independent review or examination of any records or information?;

c. They have been under any pressure or persuasion by executive directors, officers and top management to avoid reporting or highlight any issues or opinions?;

d. They have any other opinions or any additional issues or reports they wish to place before the audit committee?;

e. They have in the conduct of the audit been in any manner in conflict of interests or have had any related party issues that may have in any manner affected or impaired their independence and judgment as external auditors?;

2. There are opportunities, ways and means by which executive directors, officers and top management and even audit committees can exercise pressure upon the external auditors to refrain from transparently reporting the true and fair view of the state of affairs of the entity, especially in regard to statutory compliance failures, going concern and solvency and in regard to requirements to comply with accounting and auditing standards

3. Audit Committees should obtain annual declarations from executive directors, officers and top management in the form of a compliance declaration ,stating that “We declare to the best of our knowledge and belief and the information and documentation available and accessed or seen by us during or after the year ending…, that we are unaware of, not been informed of or heard or seen, any direct or indirect evidence (including transactions carried out via trustees and third parties retaining beneficial ownership of with entitlements) connected to businesses, business operations, transactions, accounts, minutes, correspondence, emails and voice recordings, assets, liabilities, sources and uses of funds and network alliances connected with the entity, its directors, shareholder and their related parties or associated network alliance partners, which raise any suspicion, a doubt or even a legitimate question in our mind, as to such businesses, business operations and or transactions being connected in any manner with or tainted by any criminal activity or proceeds of crime including offences covered by or associated with any criminal acts covered by the

a. Criminal Procedure Code

b. Bribery and Corruption Act

c. Anti- Money Laundering Act

d. Terrorist Financing legislation and regulations

e. Anti Narcotics trading legislation and regulations

f. Fire Arms Ordinance and associated offences

g. Securities, Banking and Finance legislation and regulations

h.Exchange Control Regulations

i. Any other serious crimes punishable under Sri Lankan or International Law And if so have duly made full disclosure of all such information, suspicions and network connections to the Audit Committee”

 

Audit quality and compliance with accounting and auditing standards

It is recommended that you collectively review the current governance environment applicable in ensuring that auditors and directors uphold, interpret and apply accounting and auditing standards correctly, especially as regards avoiding the following unacceptable situations;

• In compiling accounts carrying unqualified audit certificates, where upon due probity it is evident that these accounts
• Do not reflect a true and fair state of affairs and 
• The operations are not in conformity with statutory and regulatory compliance requirements
• Have been prepared with the intent to misrepresent the true nature of business, operational results, assets and liabilities and effective ownership and even effective domicile
• Have failed to effectively apply critical accounting standards dealing with impairment, going concern, presentation of financial statements, depreciation, consolidation and events after balance sheet date
• Carry explanatory notes reading “ Details to be completed by the Mana-gement”
• present a picture different to details of disclosures made to the Registrar of Companies and other regulatory agencies
• present a picture different to that disclosed in publicity and marketing literature and entity website disclosures

• In compiling detailed and concise accounts and reports along with audit certificates with varying levels of extents of disclosure 
• In selecting the standards applicable to the particular entity, especially in the selection of SME standard, whereas due to strategic importance, level of size and values of transactions and linkages to other associate, subsidiary or parent companies such selection is not warranted, or has been adopted as a means of avoiding scrutiny by the Accounting and Auditing Standards Monitoring Board or any other regulatory body
• Accounts being prepared in compliance with some standards and avoiding the application of other critical standards
• The audit certificate referring to one accounting standard (say SME Standard) and exceptions and qualifications with the accompanying accounts and notes not making a similar references; thus giving the appearance that the accounts have been prepared under general accounting standards
• Details of critical importance, (based on the level of size and values of transactions and linkages to other associate, subsidiary or parent companies) such as capital commitments, ultimate parent company, related party transactions, etc. not being disclosed

Statutory compliance linked to money laundering, bribery and corruption

It is recommended that you collectively review the current governance environment promoting auditors, bankers and directors to uphold statutory compliance and in preventing money laundering, bribery and corruption, with special emphasis in regard to the following;

• Ensure that effective know your customer (KYC) validations are carried out with diligence, integrity and professionalism, exercising all such probity options as expected by best governance practices,
• Ensure that Financial Action Task Force (FATF) recommendations on International Standards in Combating Money Laundering and Financing Terrorism and Proliferation http://www.fatf-gafi.org/media/fatf/documents/recommendations/pdfs/FATF_Recommendations.pdf benchmarked mechanisms are in effectively in place for assessing risks and applying risks based approach to combat such crimes, with special emphasis in the implementation of guidelines dealing with suspicious transactions and transactions with politically exposed persons
• The need for directors, bankers and auditors to significantly enhance their awareness and ensure the commitment of all critical staff members in regard to KYC and FATF commitments
• Ensuring that bankers and bank staff exercise due care and diligence in 

In regard to acceptance and credit of large value inward remittances; ensuring that the source of funds, details of remitter identity, transaction details and justification are validated;

• In regard to acceptance and credit of large value cash deposits and new deposits unless their validity and authenticity are duly validated 
• Where entity portfolios and banking relationship transfers take place, sufficient validations and interbank enquiries must be exercised
• Bank staff should not accept deposits without pay in slips and must not accept the responsibility to count and credit accounts, where undisclosed sums of money are deposited or collected from depositors offices
• Effecting large value outward remittances in currency, validating the authenticity of the transaction and authenticity of the receiving beneficiary with supporting documentation and ensuring bank advises issued have adequate descriptions for an audit trail
• In effecting transfers, purportedly approved by the authorities, taking steps to authenticate the approval documentation and seek justification of the transactions
• In reporting suspicious transactions to the Finan-cial Investigations Unit And directors should ensure that corresponding control environments are in place within the relevant business entities
• Ensure that compliance declarations are annually made by directors, officers and top management of compliance with anti-money laundering and anti bribery and corruption guidelines.
• The auditors in carrying out the audit of entities to exercise care and diligence deploying such validations as to ensure that the entity, its directors, officers and management are not tainted with any statutory and regulatory compliance violations,; and for this purpose exercise validations as deemed most appropriate including;
• Due assessment of efficiency effectiveness and economy of 
• supply chain processes,
• significant value asset acquisitions and 
• significant revenue and capital spends
• financing and fund raising process 
• mergers and acquisitions
• Compliance with systems and procedures manuals, purchasing procedures and applicable limits of authority
• Fair value assessments 
• Impairment assessments
• Comparative bench marking based assessments
• Application of forensic accounting and auditing techniques

Oversight, ethics and professional conduct validations and enforcement

A collective review of the current oversight mechanisms of the auditors, directors and bankers is recommended, along with a review of the processes and systems in place to validate ethical and professional conduct and enforcements governing directors, auditors and bankers. This review must also assess the track record of such enforcement actions in the past as well as the fairness, effectiveness and the level of deterrence, if and when penal sanctions were imposed on errant directors, auditors and bankers in Sri Lanka. The efficiency and effectiveness and the capacity of the Accounting and Auditing Standards Monitoring board and the respective Ethical and professional Standards’ Committees of the oversight bodies must also be reviewed and reformed to meet current day needs.

The persons address and copied in this mail are kindly requested to duly recognise that the above recommendations have been made not as result of frivolous information , rumours or cocktail circuit comments; but as a consequence of actual experiences and as duly witnessed or duly reported incidents revealed in the recent months . The leaders addressed are urged to recognise that it is essential that reform initiatives are an imperative and accountability falling on their shoulders in pursuit of good governance in enhancing the statutory compliance of auditors, directors and bankers. These leaders must ensure that an effective enforcement mechanism are in place and also advocate that the Government enact as an urgent step a Proceeds of Crime Act, preferably based on the Australian Proceeds of Crime Act -https://www.comlaw.gov.au/Details/C2013C00113- which appears to be a benchmark model to base the Sri Lankan statutory framework.

Chandra Jayaratne

CC. PresidentSecretary to the TreasuryPrime MinisterGovernor Central BankFinance MinisterAttorney General Minister of Development Strategies and International TradeAuditor GeneralMinister of Justice and Law ReformsCommissioner General of Inland RevenueMinister of Industry and CommerceEditors of Financial Media