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Auditing- Pay Attention to the Non-Financial Red Flags

Auditing- Pay Attention to the Non-Financial Red Flags. www.WestonSmith.biz. No single red flag may be telling, but when waving together, speak volumes . Pressure to Maintain Those Numbers Fear and Silence Young ‘Uns and a Bigger-than-Life CEO Weak Board Conflicts of Interest

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Auditing- Pay Attention to the Non-Financial Red Flags

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  1. Auditing- Pay Attention to the Non-Financial Red Flags www.WestonSmith.biz

  2. No single red flag may be telling, but when waving together, speak volumes.

  3. Pressure to Maintain Those Numbers Fear and Silence Young ‘Uns and a Bigger-than-Life CEO Weak Board Conflicts of Interest Innovation Like No Other Goodness in Some Areas Atones for Evil in Others

  4. Pressure to Maintain Those Numbers

  5. Pressure to Maintain Those Numbers

  6. Pressure to Maintain Those Numbers Healthsouth -“27 Consecutive Quarters” -Continued hype of stock -Tremendous pressure on management to meet unrealistic revenue targets -Earnings growth defied logic of reimbursement changes

  7. Pressure to Maintain Those Numbers WorldCom: Bernie Ebers- “Our goal is to be the No. 1 stock on Wall Street.” Enron: Earnings growth targets of 15-20% annually, all business units given targets derived from working backwards from EPS forecasts Tyco: Targets of 20% annual growth. Massive earnings manipulation through acquisitions Baptist Foundation of Arizona: 11,000 members lost $590,000,000 in a faith-based Ponzi scheme

  8. Pressure to Maintain Those Numbers Most earnings manipulations come through revenue recognition issues. Q: Are you faced with an obsession of “meeting the numbers?” Q: Has long-term vision been replaced with short-term objectives?

  9. Pressure to Maintain Those Numbers • Fear and Silence

  10. Fear and Silence

  11. Fear and Silence Healthsouth: Everyone- board members, officers, employees and auditors were treated with a stick and a carrot Monday morning beatings Backstabbing by the CEO Spying and blackmail by the CEO Enron: CEO Ken Lay had a “hair-trigger temper” WorldCom: A rather simplistic fraud. “The less clever the fraud, the more oppressive the culture must be because executives are asking employees to go above and beyond the call of duty in playing dumb.” Tyco: Use of Key Employee Loan Program and Relocation Loans to intertwine employees loyalty

  12. Fear and Silence Q: Is disagreeing, or just asking questions, so unpleasant that it’s easier to just go along? Q: Does the culture promote submissive attitudes? Q: Employees: Do you ever feel that your job is on the line for simply doing what’s right? Q: Auditors: Do you receive pushback from clients on routine issues?

  13. Pressure to Maintain Those Numbers • Fear and Silence • Young ‘Uns and a Bigger than Life CEO

  14. Young Un’s and a Bigger than Life CEO

  15. Young ‘Uns and a Bigger Than Life CEO Healthsouth: “of all the companies, the officers in HS were the youngest with the least amount of experience” AIG: Hank Greenburg & two sons Enron: Ken Lay surrounded by young ‘uns WorldCom: Flamboyant CEO with young officers Tyco: Dennis Kozlowski’s $6000 shower curtain Adelphia: John Rigas & 12 family members

  16. Young ‘Uns and a Bigger Than Life CEO United Way: William Aramony, former CEO– -Ostentatious lifestyle at the expense of United Way - Convicted on 22 counts of fraud

  17. Young ‘Uns and a Bigger Than Life CEO Q: Does the experience and wisdom of key employees match their responsibilities? Q: Is management composed of Yes-Men? Q: Who is being promoted- the Company or Executives?

  18. Pressure to Maintain Those Numbers • Fear and Silence • Young ‘Uns and a Bigger than Life CEO • Weak Board

  19. Weak Board

  20. Weak Board “Healthsouth takes the prize for the board with the most negative factors” • Original investors • Large ISO grants • Joint investments w/ Richard Scrushy • Self-dealing • Common directors on spin-offs • Directors were manipulated, ridiculed, and one even blackmailed

  21. Weak Board Enron: Highly paid, significant conflicts of interest WorldCom: “Bernie’s Board”, Loans to a director, personal benefits, and significant stock holdings Tyco: Asleep at the wheel, 8 of 12 were current or former Tyco employees, 4 had served >10 years on board, loan programs Adelphia: Family members dominated the board

  22. Weak Board Q: Is your Board qualified to deal with the responsibilities of the position? Q: Are they effectively fulfilling those responsibilities?

  23. Pressure to Maintain Those Numbers • Fear and Silence • Young ‘Uns and a Bigger than Life CEO • Weak Board • Conflicts of Interest

  24. Conflicts of Interest

  25. Conflicts of Interest Are decisions being made, or money being spent, solely for Officers’ personal gain or ego?

  26. Conflicts of Interest Investment Firms: There are tremendous conflicts between the research side and the sales side of the house. Smith Barney’s analyst, Jack Grubman, issued glowing reports on Worldcom until the eve of its collapse. Smith Barney would have earned $21,000,000 in fees had the WorldCom-Sprint merger been approved. The housing market collapse can be heavily blamed on conflicts of interest by lenders, appraisers, and investment firms Conflicts in the Auditing Profession

  27. Conflicts of Interest Q: Are there any related party transactions? Q: Is there any sign of self-dealing? Q: Is there an effective conflicts policy? How do you know that it’s working?

  28. Pressure to Maintain Those Numbers • Fear and Silence • Young ‘Uns and a Bigger than Life CEO • Weak Board • Conflicts • Innovation Like No Other

  29. Innovation Like No Other

  30. Innovation Like No Other “Innovators actually reach a point where they begin to believe and publicize the hype about themselves, as if repeating how innovative they are will somehow preserve the status quo, if not improve upon it.” Healthsouth: Financial indicators were substantially better than their competition Tenet: CEO comment months before revelation of abusive Medicare outlier payments: “We’re just better than everyone else” Enron: Jeffrey Skilling - “We are the good guys…we are on the side of angels”

  31. Apple- They do have innovation like no other. But they have proven themselves! Innovation Like No Other

  32. Innovation Like No Other Q: Auditors- Are your clients falling within the norm of the industry, or are they exceptionally strong or weak? Why?

  33. Pressure to Maintain Those Numbers • Fear and Silence • Young ‘Uns and a Bigger than Life CEO • Weak Board • Conflicts • Innovation Like No Other • Goodness in Some Areas Atones for Evil in Others

  34. Goodness in Some Areas Atones for Evil in Others

  35. Goodness in Some Areas Atones for Evil in Others

  36. Goodness in Some Areas Atones for Evil in Others Watch out for false prophets. They come to you in sheep’s clothing, but inwardly they are ferocious wolves. Matthew 7:15

  37. Feel free to contact me: www.WestonSmith.biz weston@westonsmith.biz @Westonspeaks

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