Date: July 12, 2021
First published in Business Times on 9 July 2021
Recent developments in the local market involving Sakae Holdings and ecoWise Holdings have illustrated just how important it is that companies have strong internal controls in place, as well as a robust internal audit function that can detect gaps and weaknesses which could compromise a company’s financial position.
In addition to ensuring strong internal audit, companies serious about enhancing their governance should consider adding a relatively new function within their senior ranks – a chief integrity officer whose job would be to spearhead integrity programmes and ensure an ethical culture is institutionalised within the company.
In Sakae’s case, external auditor Deloitte & Touche had said last year it could not obtain appropriate audit evidence and certain information related to the loss of control of a subsidiary. Deloitte also did not have enough evidence to verify the existence and recoverability of gross receivables amounting to S$5.4 million due from this subsidiary, and another $1.3 million due from a non-controlling shareholder of this subsidiary.
Deloitte also flagged that it was unable to determine if reconciled differences arising from intragroup balance were sufficiently adjusted for.
After further investigation, the issues were resolved with no indication of fraud or dishonesty. Sakae merely acknowledged that internal control processes could be further improved. It said that it had appointed an external consultant in April 2019 to review its internal control policies. The recommendations to improve the internal control processes proposed by that consultant have since been approved by Sakae’s board.
As for ecoWise, Singapore Exchange Regulation in June served it a notice of compliance to appoint two new independent directors, commission an internal audit of its internal controls, ask its statutory auditor to audit its results for the first half of 2021, and form a new audit committee (AC).
The notice comes amid a board disagreement that led to chief executive Lee Thiam Seng changing the locks of the company’s server rooms and suspending deputy chief executive Cao Shixuan.
One bone of contention was the release of ecoWise’s financial results for H1 FY2021, with Mr Lee complaining of insufficient information from the finance team reporting to Mr Cao.
In an open letter, Mr Lee highlighted that he is not “making any allegation of wrongdoing relating to the management of the operations of the group at this stage”.
He added, however, that there are “sufficient concerns and questions about the governance and internal control of the group to require me, in the fulfilment of my fiduciary duties as a director, to ask the questions and seek information”.
In Sakae’s case, internal controls appear to have been weak to begin with. This led to the red flags from the external auditor and the subsequent appointment of a consultant at considerable expense.
The same might be said of ecoWise, whose boardroom dispute suggests a severe breakdown of internal policies and communication.
The responsibility for having good internal controls ultimately rests with the board. The Singapore Code of Corporate Governance states that all boards must have an AC whose duties include “reviewing at least annually the adequacy and effectiveness of the company’s internal controls and risk management systems” as well as “reviewing the adequacy, effectiveness, independence, scope and results of the external audit and the company’s internal audit function”. The internal audit function serves as the eyes and ears of the stakeholders.
External auditors, by virtue of the limited time they have to perform their tasks, tend to rely heavily on internal auditors to decide if the published accounts are true and fair.
Over time, the role of internal auditors has evolved beyond simply checking that proper accounting is in place. The Chartered Institute of Internal Auditors describes the role of internal audit as being to provide independent assurance that an organisation’s risk management, governance and internal control processes are operating effectively.
Unlike external auditors, they look beyond financial risks and statements to consider wider issues such as the organisation’s reputation, growth, its impact on the environment and the way it treats its employees.
On top of strengthening internal controls, companies should consider adding an integrity function. At the core of such a function would be the belief that companies have a strong interest, as well as responsibility, to act with integrity at all times.
All companies should think about setting up a board-level integrity committee comprising non-executive directors and headed by a suitably qualified person. This individual should be a member of executive leadership whose role is to foster an ethical culture within the organisation and develop the appropriate programmes.
Whatever the case, the benefits of instilling ethical behaviour and integrity in companies cannot be understated.
In a 2015 report titled “Corporate Governance and Business Integrity”, the Organisation for Economic Co-operation and Development highlighted the results of an EY survey of 3,800 employees of large businesses in 38 countries in Europe, the Middle East, India and Africa.
This EY survey showed businesses that had experienced revenue growth in the preceding two years were more likely to be seen as ethical by their employees, not only at the head office, but also across operations in different countries.
The report also noted that companies with effective integrity programmes faced half of the rules violations compared to those with none. The benefits should be obvious – companies with a reputation for conducting their businesses unscrupulously or without integrity might get away with it in the short run, but over time, the market will learn of their conduct and avoid them.
Adding another function to focus on building and maintaining business integrity might seem onerous, but companies should recognise that the benefits and value of an honest and trustworthy reputation far outweigh the costs. Companies should regard an integrity function as insurance against a financial disaster stemming from the lack of internal controls.
- The writer is David Gerald, founder, president and CEO of the Securities Investors Association (Singapore)