A Risk & Financial Management Balancing Act

Information Technology ("IT") is quickly becoming one of the primary areas within a company that is not only laden with risk, but also regulatory complexity.  At the same time, IT is one of the first areas to which companies look for cost reduction in an economic recession.  The combination of these factors demands better decision making and priority-setting by IT risk professionals and finance managers to meet the needs of the business while properly managing risk. In this month's issue of Information Security Magazine, an IT risk professional at credit information provider Equifax shares his view of this challenge.

Let's face it, we are entering an era of tighter statutory requirements and rapidly changing regulations. But focusing solely on statute requirements can lead to a disjointed strategy that is neither comprehensive nor aligned with business goals. While compliance mandates are often used to drive security investments, compliance by itself does not ensure a company's security posture.

Instead, businesses must look beyond their technology and compliance needs and understand the challenges of ensuring their company's security posture. Achieving this level of transparency requires the right mix of innovation, talent and technology underscored by a strategy that addresses risk at the broadest level. This is where relationships with business partners and vendors can play a valuable role. By joining forces with industry-leading third-party providers, companies gain access to new thinking and innovation to address key needs and challenges. With the right strategy and technology partnerships, businesses can drive a consistent and global set of security practices focused on risk reduction and information security.

Wheelhouse Advisors is uniquely positioned to help companies address their risk and security challenges while meeting the financial demands of the businesses they support.  To learn more, email us at NavigateSuccessfully@WheelhouseAdvisors.com or visit our website at www.WheelhouseAdvisors.com.

Back to the Drawing Board on Derivatives Regulation

U.S. House Financial Services Committee Chairman Barney Frank (D-MA) distributed a proposal for derivatives regulation this week and it was the subject of a hearing by the committee yesterday.  A major part of the discussion centered on a potential loophole that would allow many corporations, if not all, to avoid the new regulation altogether. Here is what Bloomberg.com reported about the hearing and draft legislation prepared by Chairman Frank.

A plan offered by the Obama administration would subject all swaps dealers and “major market participants” to new regulations for capital, business conduct, record-keeping and reporting. Frank’s version would exempt corporations from that definition if they use derivatives for “risk management” purposes.

While Frank’s proposal is a “step in the right direction,” its “ambiguous” definition of risk management may leave a large number of corporations unregulated, Henry T.C. Hu, director of the SEC’s new division of risk, strategy and financial innovation, told the committee.

“As just about all swaps could be defined as being used for risk management purposes, we’re concerned that unintentionally the category of ‘major swap participant’ could have been narrowed so significantly, or even to a null set,” CFTC Chairman Gary Gensler told reporters after the hearing.

“Major hedge funds” may be excluded from oversight, as may the mortgage-finance companies Fannie Mae and Freddie Mac “because of course the government-supported enterprises use swaps for risk management purposes,” Gensler said.

It looks like Chairman Frank may need to re-educate himself on the use of derivatives and go back to the drawing board on this proposal.

Improving Executive Compensation Oversight and Pay Processes

In light of the increased risks associated with executive compensation programs, The Conference Board recently established a task force to develop guidance for companies looking to improve their pay processes and oversight.  The guidance has been published and centers on five principles that companies should strive to achieve.  Here are the five principles.

Principle One—Paying for the right things and paying for performance

Compensation programs should be designed to drive a company’s business strategy and objectives and create shareholder value, consistent with an acceptable risk profile and through legal and ethical means. To that end, a significant portion of pay should be incentive compensation, with payouts demonstrably tied to performance and paid only when performance can be reasonably assessed.

Principle Two—The “right” total compensation

Total compensation should be attractive to executives, affordable for the company, proportional to the executive’s contribution, and fair to shareholders and employees, while providing payouts clearly aligned with actual performance.

Principle Three—Avoid controversial pay practices

Companies should avoid controversial pay practices, unless special justification is present.

Principle Four—Credible board oversight of executive compensation

Compensation committees should demonstrate credible oversight of executive compensation. To effectively fulfill this role, compensation committees should be independent, experienced, and knowledgeable about the company’s business.

Principle Five—Transparent communications and increased dialogue with shareholders

Compensation should be transparent, understandable, and effectively communicated to shareholders. When questions arise, boards and shareholders should have meaningful dialogue about executive compensation.

These guiding principles seem to provide what many may say is simply common sense advice.  However, given the environment that we find ourselves in today, common sense such as this may not be as common as one might think.

The Sarbanes-Oxley Countdown is Extended for a Final Time

The U.S. Securities and Exchange Commission ("SEC") announced last week that the deadline for full compliance with Section 404 of Sarbanes-Oxley Act for small companies has been extended for an additional and final nine months.  The primary reason for this final extension is the delayed publication of the formal study on the impact of changes to the compliance requirements made in 2007.  Here is the formal release from the SEC.

This extension of time will expire beginning with the annual reports of companies with fiscal years ending on or after June 15, 2010. This expiration date previously had been for fiscal years ending on or after Dec. 15, 2009. The extension was granted so that the SEC’s Office of Economic Analysis could complete a study of whether additional guidance provided to company managers and auditors in 2007 was effective in reducing the costs of compliance. Because the study was published less than three months before the December 15 deadline, the Commission determined that additional time is appropriate and reasonable so that small public companies and their auditors can better plan for the required auditor attestation.

“Since there will be no further Commission extensions, it is important for all public companies and their auditors to act with deliberate speed to move toward full Section 404 compliance,” said SEC Chairman Mary L. Schapiro.

So, the final clock is ticking.  Does your company need help implementing a cost-effective compliance program?  If so, Wheelhouse Advisors can help.  Visit www.WheelhouseAdvisors.com to learn more.

Senate Banking Committee Chairman Presses Reform

Yesterday, the U.S. Senate Banking Committee conducted a hearing to discuss ideas for financial regulatory reform.  Senator Christopher Dodd, chairman of the committee, argued the case for streamlining the governmental agencies that currently oversee the nation's largest financial institutions.  In his remarks, he pressed the need for the creation of a new, single regulatory agency that will consolidate the handful of agencies that provide oversight today.  Here's what he had to say.

“I have heard from many who have argued that I should not push for a single bank regulator.  The most common argument is not that it’s a bad idea – it’s that consolidation is too politically difficult.  That argument doesn’t work for me,” said Dodd. “We must eliminate the overlaps, redundancies, and additional red tape created by the current alphabet soup of regulators.”  Dodd went on to detail priorities in bank regulation.  “We need to preserve our dual banking system.  And I feel just as strongly on that point as I do the earlier point.  State banks have been a source of innovation and a source of strength, a source of tremendous strength, in their communities.   A single federal bank regulator can work with the 50 state bank regulators.” The chairman also recognized the important role played by community banks.  “Community banks did not cause this crisis and they should not have to bear the cost or burden of increased regulation necessitated by others.  Regulation should be based on risk - community banks do not present the same type of supervisory challenges their large counterparts do.”

Streamlining oversight in this way will not only strengthen the regulatory framework, it will also eliminate much of the excess governmental spending and bureaucracy that currently exists.

ERM Approaches in Dire Need of Repair

This week, Forbes magazine reported results from the 2009 Global Risk Management Study sponsored by Accenture. The detailed report demonstrates the need for significant improvement in enterprise risk management approaches at major corporations across the globe. Here's a summary of the findings.

A snapshot of the results of the survey of 260 chief financial officers, chief risk officers and others responsible for corporate risk in 21 countries suggests just how much surgery may be needed to repair risk management. By huge margins, the respondents identified the following major problems:

• Ineffective integration of risk, return and capital issues in decision making: 85%


• Lack of alignment between a company's strategy and its risk appetite: 85%


• Insufficient management understanding of risk exposure types, and lack of agreement on how to mitigate such risks: 82%


• Inadequate availability of timely risk, finance and business data: 80%


• Lack of company-wide processes that could provide a complete picture of the impact of risk exposure: 78%


• Ambiguous divisions of responsibility concerning risk between corporate and business units: 78%

Following the last big downturn, in 2002, businesses attempted to adjust their risk exposure by strengthening their internal controls and improving their financial transparency. Today's world, however, requires much stronger fixes than just tweaking finance and accounting practices. In fact, businesses must fundamentally change their core risk processes.

If your company is searching for cost-effective solutions to challenges such as these, Wheelhouse Advisors can help. Visit www.WheelhouseAdvisors.com or email us at NavigateSuccessfully@WheelhouseAdvisors.com, to learn more.

Financial Regulatory Reform Debate Begins

Today, the U.S. House Financial Services Committee will welcome several experts to debate financial regulatory reform approaches.  Paul Volcker, former Federal Reserve Chairman and current Head of the President's Economic Recovery Advisory Board, will testify first by offering his views on how reforms should be enacted.   Here is an excerpt from his prepared testimony.

Important parts of the Administration’s proposed reforms can be – and some are being – implemented and enforced under existing authority. The Treasury has set out principles for capital and liquidity standards. Other prudential approaches are under consideration. Most notably risk management practices, for banks and certain other regulated institutions have been placed under urgent review. At the supervisors’ initiative, useful and needed steps are being taken to encourage more prudent compensation practices.

These are needed steps toward a stronger reformed financial system. However, I want to emphasize two inter-related issues of fundamental importance that run across the more particular elements of reform. One is a matter of broad regulatory practice: how to deal with the insidious, potentially risk-enhancing, spread of “moral hazard”, the presumption that systemically important institutions may be protected in the face of imminent failure. The overlapping question is one of administrative responsibility: in particular the appropriate role of the central bank (the Federal Reserve) in regulation, supervision and oversight of the financial system.

Mr. Volcker has defined the problem very well.  The answer lies in the need to decelerate the consolidation of financial institutions and accelerate the consolidation of regulatory oversight.  Just the opposite has occurred over the past few decades and led us to the brink of financial collapse.