REGULATORY ENVIRONMENT: INCREASING COMPLEXITIES AND CHALLENGES

1. REGULATORY ENVIRONMENT: INCREASING COMPLEXITIES AND CHALLENGES Caribbean Association of Audit Committee Members Inc First Annual Meeting June 21- 22, 2007 Saint Lucia Presented by: Esco Henry, ECCB

2. OUTLINE • Introduction • Definitions • Fiduciary Relationship between Director and Financial Institution • Role of auditors and audit committees in corporate governance • Standards - Sarbanes – Oxley Act - IFRS - Companies Act and Securities Act - Banking Act and Guidelines • Complexities/Challenges • Approaches • Conclusion

3. Introduction Corporate Governance is receiving an increasing amount of attention from both the media and regulatory bodies such as the Securities Exchange Commission (SEC) in the USA, the Financial Services Authority (FSA) in the UK, the Eastern Caribbean Central Bank (ECCB) and the Caribbean Association of Audit Committee Members Inc (CAACM) in the Eastern Caribbean. Emergence of: - International Financial Reporting Standards (IFRS) - Basel II Accord - Sarbanes-Oxley Act - Securities Act and Regulations - Banking Act and guidelines

4. Introduction Cont’d Effective corporate governance is an essential element in: - safe and sound functioning of an institution - arsenal for protection of investors; - development of money and capital markets; - elimination of systemic risk.

5. Introduction Cont’d With regulators exercising greater scrutiny over the financial affairs of institutions, the role of auditors/audit committees has been evolving and is being enlarged by international standard setting bodies – mirrored in regional benchmarks. As the bar is raised, auditors/audit committees find their roles being re-defined. They are being fashioned as major partners in maintaining corporate governance within companies.

6. Introduction Cont’d The new international rules: - complex and unachievable - the norm - might assume mandatory status in the future The challenges for regional audit committees : - create a realistic agenda for achieving compliance within established or projected deadlines; - implement the planned agenda

7. Introduction Cont’d This presentation seeks to highlight the main provisions of the regulatory framework and some of the complexities of the new standards and suggest practical approaches for converting the challenges into successful outcomes.

8. DEFINITIONS “Corporate governance” refers to: - the processes, - structures, and - information used for directing and overseeing the management of an institution. It encompasses the relationships and mechanisms utilised for achieving accountability among an institution’s board of directors, management, shareholders and other stakeholders.

9. DEFINITIONS CONT’D “Risk” refers to the uncertainty that surrounds future events and outcomes. It is the expression of the likelihood and impact of an event which has the potential to influence the achievement of an organization's objectives. “Risk Management” is a systematic approach to setting the best course of action under uncertainty by identifying, understanding, assessing, communicating and responding to risk issues.

10. DEFINITIONS CONT’D “regulatory environment” describes the body of laws, regulations, rules, guidelines and standards imposed by Parliament and regulatory authorities to govern the conduct of participants in a particular industry.

11. Characteristics of good corporate governance citizen • honesty • trust and integrity • openness • performance orientation • responsibility and accountability • mutual respect, and • commitment to the organisation

12. Fiduciary Relationship between Director and Financial Institution Fiduciary duties owed by directors are primarily two-fold in nature: • To exercise powers for the purposes for which they are conferred and bona fide for the benefit of the institution and by extension the benefit of depositors; • To avoid situations in which their personal interests and their duties to the institution conflict Section 74 Companies Act No. 22 of 1996

13. Fiduciary relationship – Duties of care diligence and skill Directors must ensure that the depositors’ moneys are protected. Diligence carries with it the requirement of giving a reasonable amount of attention to the company’s business. Directors are expected to be familiar with lending policies, numbers and value of major accounts, defaulting accounts, availability of collateral, current status and results of attempts to recover.

14. Fiduciary relationship – Duties of care diligence and skill A director is not expected to function as an expert unless appointed to the board as an expert in a particular field. He must however “act with such care as is reasonably to be expected from him, having regard to his knowledge and experience.” He must exercise reasonable care and diligence but is not liable for errors of judgment. Such reasonable care is “measured by the care an ordinary man might be expected to take in the same circumstances on his own behalf”.

15. Fiduciary relationship – Duties of care diligence and skill A director may rely on the opinion of an expert who is not a director but he must in respect of such advice exercise his own independent judgment when arriving at a decision. If he acts honestly for the benefit of the company, he discharges his legal duty to the company.

16. Breach of Duty - remedies Breach of duty attracts a raft of remedies in tort, contract law or by statute • Injunction or declaration • Damages or compensation • Rescission of contracts section 76 of Companies Act – through application to the court by member of the company to set aside the transaction and to require the director to account to the company for any profit or gain realized • Revocation of appointment of director Companies Act No 22 of 1996 section 78

17. Criminal Sanctions The legislation governing conduct of directors has created numerous offences to punish unethical or dishonest behaviour by directors of companies and licensed financial institutions Penalties range from fine of $1000 to $250,000.00 and imprisonment for up to five years • Banking Act – sections 3(5)(b), 6(4), 8(8), 9(5), 12(4), • Companies Act - section 107 (2) • Provision is also made in the Banking Act stipulating that each director is required to take reasonable steps to secure compliance by the financial institution with each requirement of the Act - section 30

18. Criminal Sanctions Cont’d • Failure to declare and register related interest and conflict of interest - $10,000.00 – section 28(5) • With intent to deceive makes false or misleading statement/omits relevant entry for audit purposes - $15,000.00 - section 29 / Companies Act 107 (2)

19. Criminal Sanctions Cont’d Section 31 of Banking Act: Liable for offences committed by the company unless he proves: - that the act constituting the offence took place without his knowledge or consent, or - that he exercised all due diligence to prevent the commission of the offence.

20. Other Sanctions Central Bank may sanction directors for: • engaging in unsafe or unsound practices in conducting the business of the institution; • violating any law, regulation or guideline issued by the Central Bank • Failure to comply with any requirement imposed under section 22 - $50,000.00 – section 22 (5) (b)

21. Role of Auditors and Audit Committees in Corporate Governance The role of auditors in general is changing to accommodate the new demands and challenges imposed by the regulatory regimes. So too is the role of audit committees. Auditors are expected to: - fulfil their traditional functions of accounting and financial control, - deliver cost and efficiency savings in their operations,

22. Role of Auditors and Audit Committees in Corporate Governance Auditors and audit committees are expected to: - respond to ever increasing regulatory and statutory requirements, and - add value to the organization as a whole.

23. Sarbanes – Oxley The Act is applicable to public companies trading securities. Main Provisions: - Public companies to evaluate and disclose effectiveness of their internal controls as they relate to financial reporting; (Section 404) - certification of financial reports by CEO and chief financial officers - auditor independence - establishment of fully independent audit committees

24. Sarbanes – Oxley Cont’d - attestation by the company’s external auditor on management’s assessment of the effectiveness of the company’s internal controls and procedures for financial reporting, - SOX forbids external auditors from: ∞ participating in the design and implementation of an institution’s financial system; ∞ providing actuarial, human resources and investment advice.

25. Sarbanes – Oxley Cont’d Conceivably, those principles may in the future be applied in our jurisdictions to institutions considered to be systemically important to the financial system – licensed financial institutions and companies trading on the ECSE.

26. International Financial Reporting Standards (IFRS) IFRS is intended to harmonise accounting practices and to make it easier for stakeholders across country borders to measure and compare performance and to truly embrace a global international accounting language. The concept of fair value accounting is perhaps the single largest problem encountered with IFRS. Criticism - increases the need for subjective valuations to be performed by reporters.

27. International Financial Reporting Standards (IFRS) Cont’d Other concerns: - difficulty in reporting on management performance since the standards focus on the balance sheet and not the income statement; - the stresses caused by additional regulatory interpretations; and

28. International Financial Reporting Standards (IFRS) Cont’d - disclosures required by IFRS represent a considerable amount of additional work, the financial statement component of annual reports being expanded up to 50% more with introduction of IFRS; - there are instances where certain types of companies and sectors have new requirements to fulfil;

29. International Financial Reporting Standards (IFRS) Cont’d IFRS has not been adopted wholesale in any Caribbean jurisdiction. The ECCB draft Corporate Governance Guidelines impose a duty on licensed financial institutions to meet IFRS requirements.

30. Companies Act Provisions (St. Kitts and Nevis Act No. 22 of 1996) mandate companies to: - keep accounting records; (section 102) - approve accounts and arrange for auditing; (section 104) - file audited accounts with the Registrar of Companies; (section 105) - appoint auditors (section 109)

31. Companies Act Cont’d The auditors duties and powers are set out in section 111 and include certifying whether : - proper accounting records have been kept by the company; and - the company’s accounts are in agreement with the accounting records and returns.

32. Securities Act Broker dealers and limited service brokers are required to maintain such accounts and other records, and file such financial statements and reports, as may be prescribed. The Minister may make regulations requiring licensees to submit to the Commission, at intervals set out in the regulations, returns of their financial resources in a form set by the Commission.

33. Securities Act Cont’d Persons licensed under the Securities Act are required to submit to the Commission, audited financial statements prepared in accordance with international accounting standards, and which contain such additional information as may be prescribed.

34. Banking Act and Guidelines The Banking Act stipulates that an auditor be appointed by each licensed financial institution. (section 19) The Central Bank may require the auditor to provide additional information as it considers necessary. The Central Bank is empowered to issue guidelines respecting inter alia: - corporate governance;

35. Banking Act and Guidelines Cont’d • policies, procedures and systems for identifying, monitoring and controlling country risk, transfer risk, liquidity risk, interest rate risk, operational risk; and such other risks as the Central Bank shall specify. Draft guidelines for internal and external auditors impose a duty on auditors to comply with international financial reporting standards.

36. Regional vs international standards Regional reporting standards are not considered to be onerous. However, the noticeable trend is for regulators to adopt and adapt international standards: - in accordance with directives from international standard setting bodies; or, - in response to international pressure for developing countries to implement the same benchmarks as developed countries.

37. Regional vs International Standards Reasonable conclusion – will region inevitably embrace IFRS, SOX and/or Basel II Accord? Gradual phasing in or more abrupt approach?

38. Complexities/Challenges Identified • Learning curve • Allocation of time • Allocation of human resources • Assessment of financial requirements • Acquisition of additional software and IT expertise (consultancy) Consequences of non-compliance: - sanctions by regulators, - possible litigation by shareholders

39. Complexities/Challenges Identified Cont’d The international standards present particular difficulties of implementation for small and developing states and institutions. While compliance is not mandatory at this time, reasonable expectations forecast reception of some of those measures.

40. Suggested Approaches Auditors and audit committees in the Caribbean basin area will be expected to quickly navigate the unfamiliar territory being forged by international standard setters in anticipation of adoption by regional regulators and in recognition of the benefits to the local and regional business environment.

41. Suggested Approaches Cont’d Research and preliminary reports by industry specialists highlight the need for training and education programmes. The benefits of networking with other institutions should not be ignored. The CAACM provides an ideal forum for members to forge alliances with one another and to organise training programmes. CAACM could position itself to serve as adviser to regulators on which standards/hybrid best serve the interest of all stakeholders.

42. Conclusion Mindful of the complexities and challenges which are inherent in implementation of the new accounting standards, regional auditors have one choice – adjust as necessary to accommodate seamless transition to the new standards. In this regard, credible and reliable information is key.

43. Questions Or Comments? Esco Henry Legal Adviser, ECCB Email: esco.henry@eccb- centralbank.org Tel: 869.465.2537