Thursday, March 7, 2013

Tone at the Top - Reinforcing Business Integrity and Ethics

The Tone at the Top

Financial management begins with the tone at the top. Christine Bruinsma and Peter Wemmenhove characterize tone at the top in the following manner:
It is the message, the attitude and the culture the board of directors disseminates throughout the organization. It is best described as the consistency among statements, assertions, and explanations of the management and its actions. Tone at the top is seen by some as a part of and by others as equal to the internal control environment.
This principle points to executive management and has utmost priority for business and financial management. Numerous past scandals teach us the importance of tone at the top. Enron’s Jeffrey Skilling, Phar-Mor’s Michael Monus and Patrick Finn, Rite-Aid’s Martin Grass serve as examples of the importance of tone at the top. Each of these executives received prison sentences for embezzlement and fraud.

The Committee of Sponsoring Organizations of the Treadway Commission (COSO) highlights some very revealing statistics about publicly traded companies. Fraud cases in them increased 18% from the decade of 1987-1997 to 1998-2007. Financial misstatements led to nearly $120 billion across 300 fraud cases. The CEO and/or CFO had some level of involvement 89% of the time. Bankruptcy and stock exchange delisting resulted from fraud discovery.

The tone at the top had significant influence on fraud and embezzlement, thereby rating its importance extremely high. Publicly traded companies have a higher degree of required financial disclosure. Consequently, it would be difficult not to conclude that privately held companies can be more prone to fraud.

According to Caroline McDonald, Senior Editor of CFO Publishing, fraud by corporate employees continues to climb according to the Quarterly Corporate Fraud Index from The Network, Inc. and BDO Consulting. McDonald cites Jimmy Lin, Vice-President at The Network, as suggesting, “The CFO has a crucial role to play in measuring the financial impact and reputational damage of fraud” and “should be an active and strategic participant in shoring up compliance and preventing fraud.”
The lack of segregation of duties and internal controls contribute to fraud or embezzlement with private small companies.

A $50 million annual revenue company engaged my services for bringing its accounting books and financial statements up to date after its accounting manager was caught embezzling funds of over $50 thousand in a two-year period. A couple of years ago, the Sacramento Bee reported that a privately held building developer suffered a similar but much larger financial loss. Two mortgage brokers in Northern California received stiff sentences in August 2012 for falsification of home sale prices and monetary kickbacks of $40,000 to $60,000 per home.

 Public and private and small and large companies alike fail to escape ethical breaches due to not having a sound tone at the top.  The small business cannot afford not having the principle of tone at the top becoming the guiding principle.  Unless integrity makes its imprint on the business, failure in areas or in the whole will negatively affect it.  Therefore, top decision makers must make the choice in the early stages of the business for gaining a sound reputation with all its constituents: employees, vendors, customers, bankers, and others who have a vested interest in seeing the business succeed.

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