Category Archives: Regulatory Compliance

PCAOB Revises Auditor’s Report

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By Chris Wright, Managing Director
Finance Remediation and Reporting Compliance Practice Leader

 

 

 

With the Public Company Accounting Oversight Board’s (PCAOB) new auditor reporting standard finally pending before the U.S. Securities and Exchange Commission (SEC) after nearly a decade in the making, Protiviti has published a Flash Report summarizing the changes and examining possible consequences.

The Auditor’s Report on Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion is intended to make the auditor’s report more relevant to investors by requiring more information about the audit. In a nutshell, the new standard requires auditors to communicate in the report any critical audit matters (CAMs) — that is, matters that were communicated or required to be communicated to the audit committee and that (1) relate to accounts or disclosures that are material to the financial statements, and (2) involve especially challenging, subjective or complex auditor judgment.

The latter distinction takes into account certain factors including, but not limited to:

  • The auditor’s assessment of the risks of material misstatement, including significant risks
  • The degree of auditor judgment related to areas in the financial statements that involved the application of significant judgment or estimation by management, including estimates with significant measurement uncertainty
  • The nature and timing of significant unusual transactions and the extent of audit effort and judgment related to these transactions
  • The degree of auditor subjectivity in applying audit procedures to address that matter or in evaluating the results of those procedures
  • The nature and extent of audit effort required to address the matter, including the extent of specialized skill or knowledge needed or the nature of the consultations outside the engagement team regarding the matter; and
  • The nature of audit evidence obtained regarding the matter

The distinguishing factor in determining whether something is a CAM is the degree to which it involves challenging, subjective or complex auditor judgment during the audit process. The audit report must include identification of each CAM, a description of the principal considerations that led the auditor to determine that the matter was a CAM, description of how the CAM was addressed in the audit, and reference to the relevant financial statement accounts or disclosures.

Because CAM determinations are subjective, some say it will give auditors leverage to encourage additional management transparency to the benefit of investors. Others see it as a significant cost, and, potentially, a competitive threat, depending on the kinds of issues discussed and disclosed.

The final standard includes other changes to the auditor’s report intended to affirm the auditor’s independence, clarify the auditor’s role and responsibilities related to the audit, provide additional information about the auditor, and make the auditor’s report easier to read.

The new standard applies to audits conducted under PCAOB standards. In addition, it specifically concludes that the communication of CAMs is not required for audits of brokers and dealers; investment companies other than business development companies; employee stock purchase, savings and similar plans; and emerging growth companies.

Subject to SEC approval, the final standard and amendments will take effect as follows (although the PCAOB allows auditors to comply with the standard before the effective date, at any point after SEC approval):

  • All provisions other than those related to critical audit matters will take effect for audits of fiscal years ending on or after December 15, 2017.
  • Provisions related to CAMs will take effect for audits of fiscal years ending on or after December 15, 2020.

One consequence to watch for is whether auditors will require disclosure of original information in articulating CAMs encountered during the audit. Limitations of the auditor’s knowledge and expertise, potential liability implications, and friction in the relationship with the company may become influencing factors that could discourage auditors from going beyond management disclosures. No doubt, this will place companies, their SEC counsel and their auditors on a collision course when it comes to deciding how much disclosure is enough disclosure.

We will continue to follow this issue and advise clients on best practices as they develop. For more detail, you can download the full flash report free from our website.

The Importance of Data Lineage for AML System

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By Vishal Ranjane, Managing Director
Risk and Compliance

 

 

 

Financial organizations have long embraced the advantages that information technology offers, and many are looking forward to larger digitalization initiatives to gain market advantage. Customers appreciate the convenience of digital offerings, while firms enjoy the reduction in operating costs that information technology enables. Of course, in the multifaceted, highly regulated environment in which financial institutions operate, mastering the complexity of this digital future is both rewarding and risky.

In any financial firm’s application landscape, data flows from system to system. In an ideal world, key data gathered at the front end (customer-facing systems) makes it to the back-end systems without hitches. In reality, in the application architecture of almost any financial institution, systems are sometimes imperfectly integrated, often as a result of multiple acquisitions, and data does not always make the journey from system to system without some amount of attrition or change. However, banks and other financial institutions that handle customer data must be able to demonstrate that the information which originates upstream, in customer-facing systems, is the same information found in the bank’s risk and compliance systems downstream. This is where data lineage becomes important.

Data lineage tells the complete story of how data within an organization was produced, consumed, and manipulated by the organization’s applications. It traces the data’s movement through systems.

Once, it was sufficient to demonstrate to regulators that the right policies were in place, that the right procedures were followed, and the right reports were generated and reviewed to protect against threats like fraud and money laundering. Now, financial institutions must be able to demonstrate to regulators that they are using complete and accurate data to monitor for these activities.

Asserting data legitimacy

An organization asserts de facto data legitimacy when it relies on the integrity of its data for key reporting or decision-making activities, such as those involved with risk and compliance solutions. It is imperative that data from upstream systems of record or points of capture arrives in these downstream risk and compliance systems in a manner that does not materially alter or obscure the content received from the system of record or point of capture.

De facto data legitimacy claims is an area of focus for regulatory authorities who require that these claims be documented and proven. The recent Part 504 regulation by the State of New York Department of Financial Services emphasizes the importance of data lineage in an AML context, stating that a covered institution must not only identify all data sources that contain data relevant to its transaction monitoring and watchlist filtering programs, but also must ensure that these programs include the validation of the integrity, accuracy, and quality of the data to ensure that an accurate and complete set of data flows into these programs. In addition, the regulation specifically notes data mapping as a key component of end-to-end pre- and post-implementation testing of transaction monitoring and watchlist filtering programs.

Going back to the firm’s application landscape, upstream data – data entered initially by the customer, for example – may not survive the journey downstream, and facts about the transaction may be lost with each hop from system to system. Can an auditor know if a particular transaction was made with a teller, a wire, or via an ATM, for example? Was a deposit made by check or cash?

Data lineage documentation can be done using a variety of tools ranging from simple to sophisticated. In smaller, less complex systems, simple spreadsheets and diagramming tools may suffice, while large financial institutions may deploy vendor toolsets to automate tedious and error-prone capture and documentation activities.

Data lineage as part of data governance

Establishing the data lineage should, of course, be more than just an exercise in documenting what’s already in place. Performing this level of analysis and uncovering previously unknown silent errors or gaps in the data being used to manage AML risks and generate reports should lead to increased accuracy and confidence in the reports and management information presented to senior management, internal audit and regulators. An additional benefit is getting better insights into customer behavior – a value for any business.

Having a sustainable data lineage initiative is only the start. To be sustainable over the long run, such initiative needs to be part of a larger data governance program that is firm-wide and involves all departments and functions. Data governance efforts are viewed well by regulators, who increasingly put pressure on financial institutions to formally document business processes, data controls, source-to-target mapping, and defend all activities around data management. A Protiviti white paper, “AML and Data Governance: How Well Do You KYD?,” provides more information and may be of relevance to your company.

Benjamin Kelly of Protiviti’s Regulatory Risk and Compliance practice contributed to this content.

States Champion Regulatory Streamlining; CFPB Remains Focused on Consumer Loan Servicing and Fair Lending

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By Carol Beaumier, Executive Vice President and Managing Director
Regulatory Compliance Practice

 

 

 

While regulatory relief remains a topic within the Beltway, the Conference of State Bank Supervisors (CSBS), the nationwide organization of financial regulators from all 50 states, the District of Columbia, Guam, Puerto Rico and the U.S. Virgin Islands, has already taken action to streamline the multistate regulatory oversight framework for one group of its regulated entities – money services businesses (MSB). In April, the CSBS launched the Money Services Business Call Report (MSB Call Report) which will allow MSBs to submit a single periodic financial form and other activity reports rather than deal with state-specific reporting requirements in varying formats. The MSB Call Report includes a Financial Condition Report, Transaction Activity Report, Permissible Investment Report and (to be added in the fourth quarter 2017) a Transaction Destination Country Report. The initial report was due by May 15, 2017. While individual states need to opt into this reporting, this move is nonetheless a step in the right direction for the MSB community.

Among the topics on the agenda of the Consumer Financial Protection Bureau (CFPB) are mortgage servicing rights for consumers and fair lending. The CFPB’s 2016 final rule amending certain provisions of Regulation X (Real Estate Settlement Procedures Act) and Regulation Z (Truth in Lending) will be effective in October 2017. The rule requires a series of modifications to the procedures and technology platforms used by mortgage services. These modifications affect, among other things, key definitions (successors in interest, delinquency), lender-placed insurance, loss mitigation, communications with borrowers in bankruptcy, and periodic statements and coupon books. With the effective date less than six months away, mortgage services need to understand and be prepared to implement all of the required changes.

The 2016 CFPB Fair Lending Report, published in April, signals the agency’s fair lending priorities for 2017. These include identification of redlining activities; mortgage and student loan servicing issues based on race, ethnicity, sex or age; and fair lending challenges faced by women-owned and minority-owned businesses. Lenders engaged in mortgage and student loan servicing and small business lending activities should consider stepping up their monitoring and testing of these areas in preparation for upcoming CFPB examinations.

Learn more about these developments in our May issue of Compliance Insights, available here, and review our monthly recap of compliance developments on the same site.

Cyber Risk Management: No More Quiet Backrooms

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By Carol Beaumier, Executive Vice President and Managing Director
Regulatory Compliance Practice

 

 

 

Last month, in New York City, Protiviti hosted a gathering of scores of financial service industry representatives to discuss the recently enacted New York Department of Financial Services’ (DFS) Part 500, Cybersecurity Requirements For Financial Services Companies. Similar in design to the previously enacted DFS Part 504, Transaction Monitoring and Filtering Program Requirements and Certifications, Part 500 requires DFS-regulated covered entities (including banking organizations, insurance companies, money services businesses and others) to develop and maintain effective cybersecurity programs and to certify annually to the DFS that they are meeting the requirements of the regulation.

The attendees – chief information security officers, chief compliance officers, chief counsels, internal auditors and other senior executives of banks and insurance companies – engaged in a lively discussion with a panel of cyber experts about the challenges of managing cyber risk and were especially honored to hear directly from DFS Superintendent of Banking Maria Vullo, who shared the reasons her agency felt it necessary to adopt this regulation, as well as her compliance expectations.

Superintendent Vullo said that “as cyber-attacks are increasing across the globe, laws and regulations are not just appropriate, they are necessary. Government must be in the game, looking ahead to help prevent misconduct.” The need for a proactive partnership between government and industry to do more to prevent and learn from cyber attacks was a strong theme throughout the Superintendent’s comments. While she recognized that many covered entities have multiple regulators all of whom may have different expectations regarding cyber risk management, the Superintendent stated her firmly-held belief that to do nothing, in the hopes of achieving a uniform regulatory approach in the U.S., was simply not an option for the DFS, and she encouraged other regulators to adopt the DFS model. From a governance perspective, the Superintendent was very clear that industry responsibility for cyber risk management rests squarely at the feet of boards of directors and senior management.

In designing Part 500, the Superintendent said that DFS’s goal was to develop “a roadmap – minimum safeguards for cybersecurity – which leave room for innovation.”  The agency’s focus will be on the outcome, recognizing that different risk profiles will require different responses. Superintendent Vullo signaled a willingness to work with the industry and share leading practices toward the common goal of strengthening the industry’s cyber resilience and said that “where we see clear cooperation and good faith effort, our response will be tempered even where there is need for improvement.”

While the DFS is still developing its cyber framework and examination program, comments from the Superintendent and from the expert panel suggested that, in addition to support from the top of the organization, several other key takeaways from the session should be noted:

  • Until there is a uniform regulatory standard, organizations – especially large, complex multinational organizations – will still need to address varying expectations and different areas of focus as they develop or enhance their cyber programs.
  • A rigorous, customized risk assessment should be the cornerstone of the cybersecurity program, and it will be important for covered institutions to step back and revisit their risk assessment process and output to ensure that it is providing the appropriate foundation for building the program.
  • While many organizations would immediately turn to IT to build the cyber program, it is very important to involve the business – e.g., materiality should be designed at the business level since IT may see the risk differently. To be effective, cyber professionals must understand the business.
  • Third-party risk management issues, which are a very complex challenge for many organizations, are critically important to the cyber compliance effort.
  • While some of the control requirements (multifactor authentication and encryption or reasonable substitutes for these) are not required immediately, the time to start thinking about them is now since implementation will take time.
  • Communication across the organization will be critical to the success of the program.

One of our expert panelists likely summed up the feeling in the room when he reflected that in the beginning of his career IT people sat in a backroom and no one much cared what they did so long as things kept working, but as technology gradually became a business enabler, the attendant risks to the business could not be ignored. Cyber is one of those risks on which every institution and every regulator is now focused.  No more quiet backrooms for the IT, business and risk professionals charged with protecting their organizations against cyber attacks; they are now front and center in the battle to protect their organizations, their customers, and the market against the growing cyber threats.

 

 

 

 

In the UK, 2017-2018 Priorities for Financial Services Firms Published

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By Bernadine Reese, Managing Director
Risk and Compliance, UK

 

 

 

The UK Financial Conduct Authority (FCA) has issued its annual business plan for fiscal year 2017-2018. The FCA is the conduct regulator for 56,000 financial services firms and financial markets in the UK and the prudential regulator for over 18,000 of those firms. Its annual business plan and mission statement gives firms and consumers greater clarity about how the regulator intends to prioritize its interventions in financial markets over the next 12 months.

The plan sets outs FCA’s cross-sector and individual sector priorities for the next 12 months. It identifies the following cross-sector priorities: culture and governance, financial crime and anti-money laundering (AML), promoting competition and innovation, technological change and resilience, treatment of existing customers, and consumer vulnerability and access.

The main individual sector priorities focus on the need to continue with the implementation of the Markets in Financial Instruments Directive (MiFID II); improving competition in all areas of financial services; supporting the implementation of ring-fencing in retail banking; and assessing the developing market for automated advice models (robo-advice) in the retail investment market.

A fundamental part of the plan is the risk outlook, which identifies key trends and emerging risks that help form the regulators’ priorities for the coming year. Technological change, cybercrime and resilience are noted as major risks. However, many of the largest risks detailed in the FCA’s risk outlook are external: international events, demographic changes, the course of the UK economy, and the impact of the UK’s decision to leave the European Union (EU), commonly known as Brexit.

We published a recent Flash Report, which lays out specifics and reasoning around each of this priorities. Financial firms in the UK are advised to familiarize themselves with the report so they can determine where to focus their compliance efforts and to better understand the regulator’s expectations.

Health Check on Emerging Growth Companies: PCAOB Reports High Incidence of Material Weaknesses

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By Charles Soranno, Managing Director
Financial Reporting Compliance and Internal Audit

 

 

 

A new white paper from the Public Company Accounting Oversight Board (PCAOB) and an April increase in qualifying revenue limits have put emerging growth companies (EGCs) in the news recently.

The EGC designation, established under the Jumpstart Our Business Startups (JOBS) Act of 2012, makes it easier for small and growing businesses — specifically those on track for an initial public offering — to attract investors and access capital by relaxing regulatory requirements and cutting some red tape. There are a number of benefits to a registrant being classified as an EGC – see Protiviti’s Guide to Public Company Transformation for what they are.

The original law established a revenue cap of $1 billion for a company to qualify as an EGC, but provided for that cap to be adjusted every five years for inflation. The Securities and Exchange Commission (SEC) made the first adjustment in April 2017, raising the revenue cap to $1.07 billion.

Another provision of the JOBS act was a mandate for the PCAOB to report via white papers, semiannually, on the extent to which EGCs actually benefitted from regulatory relief, and any unintended consequences stemming from the more permissive environment. The purpose of the PCAOB’s white papers is to provide general data about EGCs to inform the analysis contained in PCAOB rulemaking releases regarding the impact of applying new standards to the audits of EGCs.

The latest white paper, published in March 2017, found that of 1,951 companies reporting as EGCs in the 18 months prior to the reporting period, more than half (51 percent), received an explanatory paragraph in their most recent auditor’s report expressing substantial doubt about the company’s ability to continue as a going concern. Equally important, within that group of 1,951 EGC filers, 1,262 provided a management report on internal control over financial reporting in their most recent annual filing, and 47 percent – nearly one-half of all EGC filers – reported material weaknesses.

Protiviti explores the findings in the PCAOB’s March white paper at length in a recent Flash Report, but I wanted to highlight a few of the takeaways here.

First and foremost, while certain regulatory exemptions and benefits may be attractive, they do not mean that EGCs should accept or minimize issues surrounding potential findings of material weaknesses. These deficiencies in internal control over financial reporting may undermine a company’s reputation and reduce company value, to say the least.

The risk is real and should be addressed proactively. Protiviti has developed a financial reporting risk profile (FRRP) to identify financial reporting issues in advance and manage them to avoid potential financial restatements.

An effective FRRP focuses on six areas: accounting principle selection and application, estimation processes, related-party transactions, business transaction and data variability, sensitivity analysis, and measurement and planning. The underlying objective is to identify the most likely areas of potential misstatements and apply the appropriate oversight and control.

Second, EGCs should take the steps necessary to document key business processes so that these processes are well-defined and repeatable, reducing reliance on ad hoc activity by key employees. These processes may include a fair amount of financial reporting; related policies and activities, such as those that aid in the preparation of financial schedules for external auditors in the support of audits; filings; executive compensation; and employee benefits. Pre-public companies should design and implement a process for documenting conclusions on reporting and accounting matters.

Internal controls and documentation are critical because they minimize the risk of material weaknesses in the organization’s financial reporting. Consider the effects of just one material weakness: erosion of shareholder confidence, potential share price reduction, a fair amount of distraction throughout the organization, reduced brand quality, and significant remediation costs.

The high incidence of material weaknesses among EGCs is disappointing but, in many cases, generally preventable. It is important not to wait until the first auditor attestation to address potential issues. Many of the preventive measures – governance protocols, fraud controls, internal controls over financial reporting – should be in place prior to the company’s first public filing (e.g., 10Q filings, 302/906 certifications), and others should be in place prior to the initial management assertion on the effectiveness of internal control over financial reporting, as required by Sarbanes-Oxley Section 404(a). If these areas have not been addressed and the first public filing is upcoming, the organization should prepare itself by putting in place a robust remediation program. See the Protiviti Flash Report for additional points and information.

 

2017 Technologies Driving GRC Change

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By Scott Wisniewski, Managing Director
GRC Tech Advisory Solutions

 

 

 

Digital transformation was probably one of 2016’s top buzzwords, meaning many different things to different analysts, journalists and vendors. For me, it represents real and significant investments in modernizing IT infrastructures, including those that support GRC activities and processes.

Consider the trends we’re immersed in. Enterprises are adopting cloud and mobile technologies at an extraordinary rate in the hopes of driving greater productivity and collaboration, and organizations of all sizes are launching data initiatives involving the collecting and analyzing of massive amounts of data in order to drive better business decisions and improve customer experience. At the same time, the rapidly evolving regulatory environment, such as the EU’s impending Global Data Protection Regulation (GDPR), is putting pressure on legal, compliance, security and IT departments to invest in a range of new data initiatives, consulting services and technologies.

In response to the trends, organizations are rethinking their GRC infrastructures, hoping to gain a much broader and deeper understanding of risk drivers and the bigger GRC picture. Further, to make GRC work effectively in increasingly complex and highly distributed organizations, GRC leaders recognize they must embed GRC into the everyday activities of the business.

The combined impact of all these activities will make 2017 the year that GRC practitioners will:

  • Acknowledge that effective GRC cannot be achieved via a single technology or application. Instead it will depend on a new, complete architecture. A single GRC application today may expose operational risk, but it cannot develop and present the type of complete GRC picture that regulators and boards are now demanding. Developing such a picture requires the combination of traditional GRC applications and new tools to:
    • Extract data from internal systems, such as information security and ERP
    • Consume external content, such as regulatory content feeds
    • Incorporate performance metrics, such as sales and financial results
    • Collect and consolidate market and credit risks as well as the risks identified by business intelligence tools and other analytics

With all these new tools in place, organizations will finally be able to build new presentation layers that provide a complete – and far more useful – picture of their GRC profile.

  • Take advantage of increased information sharing and collaboration to improve governance. As part of their digital transformations, many enterprises are focused on developing new and more effective ways to share information and collaborate. The ability to manage and track this activity will enable GRC programs to incorporate affirmative governance components, such as corporate culture and business achievements. It will also enable the embedding of GRC program elements, such as activities assigned to Line 1 business owners, into the enterprise applications they access every day, encouraging them to more consistently follow governance best practices as they engage in their daily activities.
  • Improve risk decision-making by using data analytics. Thanks to an array of new technologies – in-memory computing, visualization tools, mobile reporting services, etc. – organizations can now rapidly aggregate and analyze huge volumes of data from systems across the enterprise. Data scientists are also developing new methodologies and business rules to aggregate and optimize data for analytics more effectively. As a result, organizations will finally be able to automate many GRC tasks, such as risk scoring assessments, thereby automatically exposing potential risk hot spots that previously went undetected until the damage was done.

I have never been more optimistic about the evolution of GRC. As assurance professionals, lines of business and IT work together to implement new strategies and new supporting technologies, we will transform GRC from mere operational risk management to a function that can protect organizations while actually helping them to be more successful.