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Reeling them in

01 February 2006 Anton de Sousa

The regulatory environment is undergoing profound changes that will put additional responsibilities on company directors and alter the complexion of the financial services industry forever.

Today directors have become more liable for their actions and are further required to play a more hands-on role than before. The stick is the hefty penalties they could face in the event that their actions are deemed to have amounted to a dereliction of fiduciary duties.

Ernst & Young has released the results of a survey that examines the challenges confronting companies that have to comply with Sarbanes-Oxley (SOX) regulations. The survey, titled Emerging Trends in Internal Controls: Fourth Survey and Industry Insights, sampled more than 250 companies and provides industry specific data for increased relevance and value of SOX compliance.

Anton de Souza, Ernst & Young Lead Partner in Financial Services, says the findings of the survey were quite telling on the changing roles of directors in the financial services sector.

Shareholders and management alike have indicated that they are impacted by the sweeping changes bought about by increasingly tough regulations. While executive management is playing a more active role in the running of the company and ensuring that deficiencies are identified and corrected, shareholders have taken solace in the fact that there are enhanced financial controls, better accountability and their concerns are addressed beyond financial reporting, says De Souza.

In order to preserve and build upon goals in the controls environment, management must communicate proactively and frequently to reinforce the overall control consciousness of the organisation. This message must be reinforced so that the tone at the top is mirrored and evident with the actions in the middle of the organisation.

The survey found that the financial services industry has experienced potential areas of value generation since it embarked on the path to SOX compliance. Some 41% of financial services companies conceded that the changes have led to significant added value in enhanced accountability for and ownership of controls, while 23% said the continuous process of SOX compliance has significantly enhanced financial processes.

A further 17% said they have experienced significant systems enhancements in contrast to 36% who admitted that tighter regulations have added some value.

The new framework has created a regulatory environment that has enhanced the attractiveness of organisations to global capital flows. Global capital providers will require similar controls elsewhere as they do in US-listed companies, says De Souza.

He cautions though, that compliance to SOX as revealed in the survey comes at a cost.

Some 18% of banks surveyed conceded that the total SOX costs are greater than $25 million, 9% said they will be $10 to $25-million while 28% conceded that the costs to compliance will be $5 to $10-million.

Large South African banks, for example, have publicly indicated that the direct costs of Basel II implementation will be in excess of R200-million per bank, an indication of the possible costs of SOX implementation for South African business.

Integral to SOX compliance, companies have to uncover and fix deficiencies in their internal control processes. The survey reveals that 20% of financial services companies have identified and remediated 250 internal control deficiencies, says De Souza.

The study has tackled the challenges that face SOX-related controls within processes outsourced to third-party providers. Many companies recognise that prior to SOX, controls at third party providers may not have been reviewed to the extent required, especially given third party providers increasing prevalence and importance, says De Souza.

He adds: In order to avoid suprises, third party providers should be addressed as early as possible within the internal control environment. Financial institutions in particular are improving their monitoring of third party providers cataloguing all third party transactions, risk rating outsourced operations, analysing the number and size of the transactions being processed and determining the effects on the internal control system.

De Souza advises that financial services companies have to start early to identify and address potential areas for control deficiencies, especially those resulting from new acquisitions, mergers and system changes.

Although the global market requires companies to bolster their internal control environment, we suggest that companies should get their houses in order early as this is a long journey with good paybacks, De Souza concludes.

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