Economic Crisis – Auditors Evolving Role IAA Charlotte March 17 2010

1. Economic Crisis –Auditors Evolving RoleIAA Charlotte March 17 2010 Michael P. Cangemi CPA, CISA Former CAE - CEO Etienne Aigner & FEI Advisory Board Member – FASB, COSO Management, IT, Financial Governance 1 Cangemi Company, LLC

2. Business Career • Merrill Lynch/Blair&Co – High School&College • Ernst & Young – CPA – Dir IT Audit • Phelps Dodge – CAE – VP - CIO • Professional work – IS Control Journal (87-07) & Books - Managing the Audit (Wiley) • BDO Seidman Ptr. IT Audit – IA Services • CFO/COO to CEO Etienne Aigner, Inc. 91-04 • CEO Financial Executives Intl 07-08 • Advisory Boards – FASB; Pace Univ.; private companies; Rutgers CA/CM – fmr COSO Management, IT, Financial Governance 2 Cangemi Company, LLC

3. Leverage infused Credit Crisis • Lehman Brothers – wiped out • Bear, Merrill, Wachovia – merged • 200+ banks taken over by FDIC • 32-1 leverage – more on this risk later • AIG- regulated company – Gov take over • GM- non -regulated – Gov take over • " Greenspan said, "We are in the middle of a once-in-a-century credit tsunami."

4. Today’s Goals: Managements Prospective • Crisis – impact on your business • Recession puts pressure on costs – even audit and recently IT spending; efficiencies from IT have been #1 cost reduction driver • What else auditors should be doing! • Fraud risk always present: rises in downturns – but always present!

5. Credit Crisis - Primer • Recent History • What caused this Credit Crisis • Easy Monetary Policy And • A simple financial instrument

6. Sub-Prime Malfeasance • A mortgage was a safe loan • Securitizations -Packaged into Mortgage Backed Bonds – Fee income for IB • Packages of Mort-Backed Bonds into Collateralized Debt Obligations (CDO) • Good collateral – until no money down, interest only, credit scores don’t matter • House prices declined = crash!!!

7. Roots of a problem Community Reinvestment Act Born in the Carter Administration Praised by Bush- Clinton- Bush Ordered banks to extend loans to minorities; lead to more loans Fannie & Freddie offered to securitize the loans – Congress expanding home ownership!!!

8. If not Bad Guys – Fee Income is gone Management, IT, Financial Governance 8 Cangemi Company, LLC

9. Market Cycles 101

10. Blame game • Lax Credit criteria – system of moving risk to others – after taking fees • Unregulated mortgage brokers • Add 2% and 20% --- leverage • Lack of adequate regulation –CDO’s • Soft regulation on Short selling • Rating Agencies – big issues!!

11. Fair Value Accounting • Not the problem – always used LCM • FASB-IASB issued guidance in reaction • SEC reviewed Fair Value Accounting Jan 09 • FASB issued guidance on valuations • 157e Determine when a market is Not Active • 115a Other than Temporary Impairment BIGGER ISSUE is sovereignty and regulatory oversight of accounting under IFRS

12. Wall Street & Derivatives- CDOs What are credit default swaps – insurance – maybe or bets – shorts and longs –weak regulation (Bucket Shops – Jesse Livermore) New Regulations coming –BIG Changes mandate oversight over the credit default swaps market& more regulation of short sales

13. New Regulations – • Federal reserve gains regulatory power • over “too big to fail” institutions • Financial Services Oversight Council • Addresses gaps in regulation • Consumer Financial Protection Agency • new rules over credit cards, mortgages and other consumer products

14. Three selected Mega Trends • Sever recession – credit contraction • Globalization - Competition • Rise of Elephant & Dragon; Brazil etc. • Expansion of Global Capital Markets - Global Shift: • 2003 US was 44% - 2007 33% • Audit costs basically doubled – but recently rationalization of SOX costs

16. What is in our post crisis future? A slow economy – recession or “Great” Initially major impact from drop in capital markets - losses of 401K • Market has come back – avoided crash Management Perspective -much higher unemployment Lower consumer spending – lower USA - GDP

17. New Playing Field • Eco Crisis leads to BIG changes – • GM Bond holders lose to employees • Gov takes equity and management decisions • Fed - systemic risk regulator; • SEC-PCAOB? • New consumer regulator

18. What will be the “New Normal” High levels of Government Debt Very large Government – new regulations Inflation – around the corner Higher taxes & Savings= lower consumer spending –on goods and services Continued difficult business environment What are you changing? Management, IT, Financial Governance 18 Cangemi Company, LLC

19. React to the New Normal • US will be less of an economic power • Maybe US $ replaced by a basket • More outsourcing – to lower cost countries – accounting, audit & IT • Difficult Business environment – should lead to innovation – lots of changes

20. New Normal – Audit –IT Audit • Get in the flow with management • My Book: Periodic Audit Mgt Change • Innovate/Reinvent - Respond • Larger focus on formal ERM - GRC • To Do- Lower cost – higher imagination • COSO Continuous Audit & Monitoring • Discuss further greater coverage lower cost! • Outsourcing audit – Global

21. ERM - • Banks measure credit risks – programs based on underlying financial strength ratings and probabilities • In non-financial there are many different business risks – boards address on an ongoing basis; not as obvious • All subject to management override

22. Audit Involvement in ERM • Basically a good thing – to a degree • BUT – What is ERM and note it works until management overrides • Leman; Merrill; Bear – had risk models • Trying to apply Fin Company risk model My advice: • Set your Audit Charter realistically

23. Leverage – 1929 in a new form • 32 to 1 – are you kidding!! Say you raise $10,000,000 • Now investing $320,000,000 - OPM • Earn 2% Fee = $6.4 M vs. $10 M raised Did IA have a risk comment – ERM ?? Buffet’s comments in DC : 2% & 20% rule

24. COSO - ERM • page 3 -“ERM enables management to effective deal with uncertainty.” • Page 5 - Achievements of strategic objectives and operations, however, is subject to external events not always within the entity’s control • Page 13 - All entities face uncertainty the challenge is for management - how much uncertainty is it prepared to accept? Question – how do you determine how much of an unknown you are prepared to accept.

25. IA Adding Value ROI Challenges • Not producing products or revenues!! • How do you contribute more to the business? • Set IA Charter High – Improve control; E&E of ops and positive deliverables • IA – People, Procedures – Reports • Take advantage of automation

26. IA Adding Value – ROI • Use of Technology – • different solutions by sizes of company • Continue to expand use of automation for administration and audit testing • Use leverage – recommend built in CM controls testing to business units; help them implement

27. COSO Cube • Recognized as the major framework for evaluating internal control • Opportunity to build in controls; save money; increase coverage; find errors; recover $$$

28. New Normal for Audit - Monitoring - Make Audit efficient A means to control efficiency and effectiveness. “Management should be able to rely on self-assessment and, more generally, the monitoring component of internal control, provided the monitoring component is properly designed and operates effectively” (PCAOB, AS5, P. 5)

29. Concepts of Monitoring

30. New Generation – CM Software • ACL; IDEA; Approva & Oversight • Oversight Systems • No business process works perfectly. The sooner an error is identified and corrected the better. Oversight's advanced analytics inspect each step in every transaction in a financial business process to identify fraud, misuse and error.-- Oversight Systems

31. New Normal - Oversight’s continuous auditing solution • built-in report and dashboard features that present continuous risk reports with color-coded risk ratings (i.e., red, yellow, and green) for all key control objectives. • threshold-oriented reports automatically alert audit professionals

32. Audit Dash boards

33. Click-through to Relevant Exceptions © 2007 Oversight Systems

34. Plain Language Exception Descriptions © 2007 Oversight Systems

35. New Normal -Lower Audit Costs Costs - SOX caused audit cost to increase Now is the time to rationalize, make the control structure more efficient CCM is an answer to expanded ERM EDPACS Article – case studies Fraud – everyone now tuned in to possible fraud – thanks to Bernie et al – CCM – it will continue!!!

36. Financial Scandals & Markets • Financial Scandals are not a new phenomena Management, IT, Financial Governance 36 Cangemi Company, LLC

37. Recent Financial Market Crises • 1980s Saving & Loan Bailout • 1987 Market drop and rapid recovery • 1998 Long-Term Capital failure & fallout • 9-11-2001 – terrorist attacks • 2001-02 - accounting scandals and bankruptcy's –some caused by bad guys • 2007-08 sub-prime induced dislocation-some again caused by bad guys

38. Discovery of America – New Land Schemes Management, IT, Financial Governance 38 Cangemi Company, LLC

39. Madness of Crowds • The Tulip Bulbs Bubble 1600’s – emotional market ?? • South Seas & Mississippi Companies – UK investors bet on America • 1800-1900 Rail Roads Bubble • 1990’s Internet Bubble • 2000’s corporate frauds leads to SOX! Management, IT, Financial Governance 39 Cangemi Company, LLC

40. Bad Guys circa 2009 - Global • SociétéGénérale – one trader $7.2 billion loss • Bernie Madoff – never bought a security • Texas financier R. Allen Stanford -sold CDs in US kept the cash –Global Fraud! • Venezuela "seized a failed bank controlled by Stanford after a run on deposits” • UBS Off Shore Accounts Investigation

41. Closing Thoughts Audit is a business – must be efficient Business run on cash Try for cash recoveries Lower expenses Careful expanded focus on GRC- ERM Be creative – innovate – high imagination low cost solutions – use automation Think Globally Management, IT, Financial Governance 41 Cangemi Company, LLC

42. Questions? Management, IT, Financial Governance 42 Cangemi Company, LLC

43. Cangemi Company LLC • Senior Advisor & Board Member • Consulting –Financial, Strategic & Governance , Internal Audit • Media -speaking; teaching • Book -Managing the Audit Function; available at Amazon, Wiley and other book sellers • mpcangemi@msn.com Management, IT, Financial Governance 43 Cangemi Company, LLC