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Honing Skepticism

Remember President Ronald Reagan’s foreign policy mantra, “Trust, but verify”? That idea is at the heart of a collaboration by leading business organizations, including NACD, to prevent fraud by honing the skill of skepticism in the financial reporting chain, which leads right through the boardroom.

Editor’s note: This article is based on webinars financial reporting chain, including directors. and related research conducted as part of an Everyone involved in a company’s financial re- ongoing Anti-Fraud Collaboration initiative porting effort can benefit from skepticism. After ­(antifraudcollaboration.org). As such, it reflects all, they need every possible weapon at hand contributions from Anti-Fraud Collaboration to hack away at the legendary fraud triangle, members. Responsibility for the content of this ar- the three factors—as explained in the Center ticle, however, lies solely with NACD. for Audit Quality’s 2010 report Deterring and ­Detecting Financial Reporting Fraud: A Platform Must directors be skeptics? for Action—­ that when combined often lead indi- It’s a challenge worth examining. The term viduals to commit fraud: pressure (or an incen- “skepticism” is often associated with doubt, but tive or motive) to engage in fraud; a perceived it actually describes a search for the truth. The opportunity; and the ability to rationalize fraudu- word comes from the Greek skeptikos, used some lent behavior. A passage from that report reveals 2,300 years ago by disciples of the philosopher the magnifying power that skepticism can have: Pyrrhus. The verb skeptesthai means “to reflect, “Skepticism throughout the financial reporting look, view.” supply chain increases not only the likelihood The earliest self-declared skeptics empha- that fraud will be detected, but also the percep- sized the importance of the senses in confirming tion that fraud will be detected, which reduces ­reality. Over time, the word’s meaning expanded the risk that fraud will be attempted.” to include the notion of reasonable doubt. The CAQ report notes that exer- Today, the “skeptic” is perceived as a doubter, cises skepticism by periodically testing assump- someone who may trust but must always verify. tions about financial reporting processes and As such, embracing skepticism carries unique controls, and recommends that boards and audit role-related challenges for each member of the committees take a skeptical approach in their

January/February 2013 www.directorship.com 29 Cover Story

work. The report also states that for both internal desirable director trait. BRT’s 2012 Principles of and external auditors, skepticism is integral­ to the notes that “effective direc- conduct of their professional duties, pointing out tors maintain an attitude of constructive skepti- that those auditors can “provide insight into the cism; they ask incisive, probing questions and company’s ethical culture and the effectiveness of require accurate, honest answers.” its internal controls to assist board and audit com- “If we take a look at the widely reported fail- mittee members in exercising skepticism.” ures that have recently occurred, many times it’s a lack of adequate skepticism that is the common Sharpening Independence denominator. But skepticism is very different from Although no professional standard requires di- playing devil’s advocate, asking uninformed ques- rectors to exercise skepticism, this attitude is tions or being argumentative,” says NACD Presi- “Skepticism clearly implied by the concept of director inde- dent and CEO Kenneth Daly. “It’s about under- pendence, required in the United States under a standing the industry and the business, applying is very number of existing standards set by Congress, the your business acumen to the subject matter, different from Securities and Exchange Commission and the and requiring logical responses to relevant, well- stock exchanges (see related sidebar, “Director formed questions.” playing devil’s Independence Requirements,” opposite page). advocate.…It’s Director independence—as interpreted today A More Effective Chair about applying by leading organizations including the NACD— The audit committee chair plays an important role requires an independent mind-set; this in turn in the exercise of skepticism needed for indepen- your business makes skepticism possible, as the two traits are dence. An effective chair does a lot of pre-work acumen to closely related. with the CFO, the chief executive NACD has long recognized independence and and the external auditor. As the chair facilitates the subject skepticism as valuable traits for audit committee the meeting, it is important for him or her to know matter and chairs. The 1999 Report of the NACD Blue when to go deep and when it is time to come back requiring logical Ribbon Commission on the Audit ­Committee: up to the real issues. A Practical Guide linked audit committee ef- “I know from my experience sitting on audit responses fectiveness to the “independence, competence, committees for multinational companies that to relevant, dedication and leadership skills of the audit there is a lot of complex information behind each well-formed committee chair.” The commission, led by the ‘number’ for a ,” says Hooper. late A. A. Sommer Jr., a former commissioner of An effective chair solicits input from all audit questions.” the SEC, noted that the chair “will ideally be committee members, not just the designated ­—Kenneth Daly a highly respected, highly experienced director ­financial expert. Indeed, sometimes the best who demonstrably possesses the attributes of questions come from people with nonfinancial ­intellectual curiosity, a skeptical eye and ear, te- backgrounds. nacity and courage.” Audit committee oversight and support of in- A subsequent commission—co-chaired in 2010 ternal audit are essential for assuring an indepen- by Dennis Beresford, former chair of the Financial dent, objective and skeptical internal audit func- Standards Board; and Michele­ Hooper, tion. Audit committees have primary responsibility audit chair at PPG Industries, director of United- for hiring the external auditor, as mandated under Health Group and NACD, and co-chair of the Anti- the Sarbanes-Oxley Act of 2002. Clearly, audit Fraud Collaboration, an initiative supported by the committees should assess skepticism when se- CAQ, Financial Executives International, the Insti- lecting auditors or evaluating their performance. tute of Internal Auditors and NACD—reinforced But this is not the only role they play. these same themes. The NACD Blue Ribbon Commission report Business Roundtable also cites skepticism as a warns, “Effective audit committees are not and

30 NACD Directorship January/February 2013 cannot be auditors.” Rather, audit committee independent data points, this may point very members should focus on reviewing financial early to…a potential problem.” risks and overseeing risk management. “While Directors can benefit from the advice offered they should exercise constructive skepticism as in Enhancing Board Oversight: Avoiding Judg- they question management and auditors about ment Traps and Biases, a March 2012 publica- the quality of management’s financial reporting tion produced by the Committee of Sponsoring and the quality of controls, they must rely for Organizations. Authors Steven M. Glover and the most part on the financial and reporting Douglas F. Prawitt note that “…in a world of ­judgments of the full-time managers and profes- high-stake decisions, deadlines, and limited ca- sionals, and the advice and reports of the audi- pacity, the judgments of even highly educated, tors,” the report states. capable people are vulnerable to common, sys- “Deviance from revenue recognition policy tematic traps and predictable biases.” “Deviance is frequently the most common example of fi- Using an example from the audit realm, nancial statement fraud in a company,” explains Glover and Prawitt note that in collecting and from revenue Martin M. Coyne II, lead director and audit assessing audit evidence, auditors often are con- recognition committee member at Akamai Technologies. fronted with issues that need to be addressed. “An audit committee can start by looking at a Therefore, they need to identify the problem policy is policy, then move to what adjustments have been (for example, sales revenue is inconsistent with frequently the suggested by the external auditor, then move to customer counts) and then begin to consider al- most common items like the number and size of credits issued ternatives (why might sales revenue be higher in and the trends in bad debt reserves and revenue this period when the number of customers has example reserves. If you connect the dots from all of these decreased?). of financial statement fraud Director Independence Requirements in a company.” The Sarbanes-Oxley Act of 2002 requires inde- governance committees must be independent— ­—Martin M. pendence for public company audit committee thus extending beyond SOX and Dodd-Frank members, and the Dodd-Frank Reform when it comes to the nominating/governance Coyne II and Consumer Protection Act of 2010 requires committee. ­independence for compensation committee Nasdaq also states that a majority of directors on members. These requirements apply to all public the boards of listed companies must be indepen- companies, regardless of stock exchange, with dent, defining an independent director as one who few exemptions. Furthermore, stock exchanges is not an executive officer or employee of the listed have specific independence requirements. company, and who, in the opinion of the board of The New York Stock Exchange requires that a directors, has no relationship that would interfere majority of directors of its listed companies be with the exercise of “independent judgment” independent. An “independent director” under in carrying out the responsibilities of a director. NYSE rules is one who the board has affirmatively Nasdaq also requires that all members of the audit determined has no “material relationship” with committee be independent. The compensation the listed company. This definition applies for all committee requirements must conform to Dodd- purposes throughout the NYSE listing standards, Frank as described above. As for the nominating/ except that additional restrictions, consistent with governance committee, director nominees are se- Section 301 of Sarbanes-Oxley, apply to member- lected or recommended for the board’s selection ship on the audit committee. In addition, all mem- by an independent nominating committee or by a bers of the audit, compensation and nominating/ majority of the independent directors.

January/February 2013 www.directorship.com 31 Cover Story

Glover and Prawitt, both professors at Brigham 2012 Staff Audit Practice Alert, those standards Young University, propose the following COSO- require that each individual auditor on the en- endorsed model as a process for avoiding bias: gagement team apply professional skepticism 1. Define the problem and identify funda- throughout the audit. Here are some highlights mental objectives. closely paraphrased from the executive summary 2. Consider alternatives. of that document: 3. Gather and evaluate information. ■■ PCAOB standards (AU 230.07) define pro- 4. Reach a conclusion. fessional skepticism as an attitude that includes a 5. Articulate and document the rationale. questioning mind and a critical assessment of au- dit evidence. The standards also state that profes- The Audit Committee’s Role sional skepticism should be exercised throughout “You don’t The topic of director independence, and in par- the audit process, particularly in areas that involve ticular the skill of skepticism, has received new significant management judgments or transactions have to be attention in light of the Concept Release on outside the normal course of business. mean to be ­Auditor Independence and Audit Firm Rotation, issued by the Public Company Accounting Over- Tips for Audit Committees tough.” sight Board in August 2011. Directors serving on ­—Mary Mitchell some audit committees may need to be more ■■ Empower your audit committee, wheth- skeptical—not only of the financial executives er or not you belong to it. These committee who work for their firms, but also of the internal members, selected for their expertise and/or auditors and the external auditors. independence, are in an ideal position to ask Audit committee members can help promote the right questions of management, the inter- professional skepticism by all the other partici- nal auditor and the external auditor. pants in the financial reporting chain—including ■■ Even if you are not an auditor, see what external auditors. That is, directors have a role in you can learn from them. In addition to their ensuring auditor skepticism. As stated in the 2009 professional skepticism skills, auditors assess SEC Handbook (Section 603.07): “SEC regis- fraud risk and develop audit procedures and trants may, of course, change auditors at their dis- tests to respond to those risks. If you under- cretion. It is imperative, however, that when a new stand the potential risks of fraud in your com- auditor is engaged that [the] auditor possesses the pany, you can determine how to mitigate those integrity, objectivity and independence required risks. by professional and Commission standards. The ■■ Support the internal audit function. An auditor must, at all times, maintain a ‘healthy independent and objective internal audit func- skepticism’ to ensure that a review of a client’s ac- tion contributes to a strong control environ- counting treatment is fair and impartial.” ment and can be invaluable in deterring and Judging from the comment letters received detecting fraud. by the PCAOB on the subject of mandatory au- ■■ Encourage vigilance by financial execu- ditor rotation, there are serious drawbacks to this tives. Questions aren’t just for auditors and the practice, which can be expensive, unwieldy and audit committee; financial executives can pose risky. But this does not mean that audit commit- them early on in the financial reporting pro- tees and auditors should be complacent. The cess, preventing that infamous fraud triangle better they do their work, the less need for man- from taking hold. datory auditor rotation. ■■ Adopt a positive approach, with proper Professional skepticism is essential to the etiquette and good ethics. Civility and integrity performance of effective audits under PCAOB can help you ask tough questions effectively. standards. As the PCAOB notes in a December

32 NACD Directorship January/February 2013 ■■ Certain circumstances can impede the ap- with the external auditor. propriate application of professional skepticism Fornelli also suggested implementing an an- and allow unconscious bias to prevail, including nual assessment of the auditing firm and the lead incentives and pressures resulting from certain audit partner. Best practices for such an assess- conditions inherent in the audit environment, ment might include a review of compliance with scheduling and workload demands, or an inappro- the various independence requirements, along priate level of confidence or trust in management. with the application of objectivity and profes- ■■ Firms’ quality control systems can help sional skepticism, followed by an audit com- engagement teams improve the application of mittee disclosure on the results of the evaluation. professional skepticism in a number of ways, (On this last point, NACD has helped to develop including setting a proper tone at the top that a tool, which is available at NACDonline.org, for emphasizes the need for professional skepticism. directors that assists in the evaluation of the ex- “Audit quality ■■ The engagement partner is responsible for, ternal auditor.) among other things, setting an appropriate tone has improved, that emphasizes the need to maintain a question- The External Auditor but we must ing mind throughout the audit, and to exercise As mentioned, external auditors define skepticism professional skepticism in gathering and evaluat- as “an attitude that includes a questioning mind and not let down ing evidence, so that, for example, engagement a critical assessment of audit evidence.” our guard. The team members have the confidence to challenge According to the audit standard Due Professional CAQ believes management representations. Care in the Performance of Work (AU 230), “The ■■ It is the responsibility of each individu- auditor uses the knowledge, skill and ability called that audit al auditor to appropriately apply professional for by the profession of public accounting to dili- committees skepticism throughout the audit, including in gently perform in good faith and with integrity, the identifying and assessing the risks of material gathering and objective evaluation of evidence.… should be misstatement, performing tests of controls and The auditor neither assumes that management further substantive procedures to respond to the risks, is dishonest nor assumes unquestioned honesty.” strengthened and evaluating the results of the audit. Back in 2000, the Report and Recommendations At a March 2012 public meeting in Wash- of the Panel on Audit Effectiveness noted that this and ington, D.C., hosted by the PCAOB, Cynthia definition is often characterized as the “neutral” empowered to M. Fornelli, executive director of the Center view of skepticism. take on more.” for Audit Quality, expressed her views on the The auditing standards that focus on fraud talk role of the audit committee in promoting and about auditors having to presume some level of —Cynthia M. maintaining audit quality. “Audit quality has im- dishonesty in the preparation of the financial state- Fornelli proved, but we must not let down our guard,” she ments unless the audit evidence indicates other- said. “The CAQ believes that audit committees wise. This is referred to in academic literature as should be further strengthened and empowered “presumptive doubt”: “The auditor should con- to take on more.” duct the engagement with a mindset that recog- One way to strengthen the independence of nizes the possibility that a material misstatement the audit committee and auditor relations—sug- due to fraud could be present, regardless of any gested as an alternative to mandatory audit firm past experience with the entity and regardless of rotation—is to allow the audit committee to se- the auditor’s belief about management’s honesty lect the lead engagement partner on an audit, and integrity. Fornelli said. Audit committees would also need “Furthermore, professional skepticism re- to be satisfied that their members have the nec- quires an ongoing questioning of whether the essary technical competence and experience, information and evidence obtained suggests that which would set the tone for the relationship a material misstatement due to fraud has oc-

January/February 2013 www.directorship.com 33 Cover Story

curred. In exercising professional skepticism in ally make judgments, so it is beneficial to under- gathering and evaluating evidence, the auditor stand the process used in making judgments. should not be satisfied with less-than-persuasive Auditors typically develop multiple alternatives evidence because of a belief that management and test them by gathering evidence and evaluating is honest” (AU 316, Consideration of Fraud in a the information. For example, if financial reports Financial Statement Audit). indicate that a company has higher sales revenue Today, auditors face a much more complex but fewer customers (a scenario mentioned earlier financial world. As Michele Hooper points out, in the COSO model), there are several alterna- there was a time when financial reporting was tives to consider: fewer customers are purchasing much simpler—companies used historical costs, more items, the current customers are purchasing and the volume of transactions was smaller. higher-priced inventory resulting in higher rev- “The volume “The volume of transactions has increased ex- enue, the company has adopted a strategy of fo- ponentially, the majority of the transactions are cusing only on high-volume customers, or perhaps of transactions automated, and many issuers have collateralized the company is booking sales for the next period has increased debt obligations, as well as complex assets for in the current period to meet sales goals. In the which it is difficult to obtain reliable estimates course of working through an audit issue, the au- exponentially, because they are not widely traded,” she says. ditor will weigh evidence that supports his or her the majority of alternative theories with that which disconfirms the transactions Training Auditors the alternatives under consideration. Once he or Few people are “born skeptics,” but everyone she reaches a conclusion, the next step in the judg- are automated, can learn how to apply skepticism. Today it is ment process is to articulate the findings and docu- and many embedded in auditor training. Given the ever- ment the rationale for that conclusion. growing complexity of the transactions they are As an auditor or other professional goes issuers have looking at, auditors are obliged to be even more through the judgment process, it is important to collateralized skeptical than in the past. “What’s really impor- recognize the traps that might lead people to the debt tant is experience…the way you really learn as an wrong conclusion. It is human nature to develop auditor,” says Gregory G. Weaver, chairman and alternatives that will support the original solu- obligations.” CEO of Deloitte & Touche LLP. tion to a problem that has been identified. This ­—Michele For auditors to be able to exercise professional is often referred to as “confirmation bias”—you skepticism in response to a given set of evidence, want to gather as many facts as possible to support Hooper they must be on high alert for patterns and anoma- what you believe will be the ultimate conclusion lies. As Mark W. Nelson, a professor of accounting (e.g., that the company has shed low-volume cli- at Cornell, writes in Model and Literature Review ents and has succeeded in increasing sales to its of Professional Skepticism in Auditing, published higher-volume customers). Auditors are trained in the November 2009 issue of the academic to expand the enumeration of possible alterna- journal Auditing, auditors “must understand the tives to include those that will make one question directional implications of evidence of audit risk, the validity of the evidence that they are consid- and also must be able to apply their knowledge of ering. Contradictory evidence is not something to evidential patterns and error/nonerror frequencies be dismissed in the conduct of the audit. to determine whether a given set of evidence sug- Training reinforces the need to carefully ex- gests a heightened risk.” amine all disconfirming evidence and to con- Being able to understand evidential patterns tinue to ask questions—is this consistent with is a skill developed through experience, and that historical trends, and if not, why not? experience is often gained through the supervi- What can other participants in the financial re- sory review of work throughout the audit. The porting supply chain learn from external auditors nature of the audit requires auditors to continu- with regard to skepticism? Financial statements

34 NACD Directorship January/February 2013 are composed of a series of estimates, and there is working, but one who investigates and verifies is a great deal of information that goes into those before jumping to a conclusion.” estimates. Business has become more complex, and accounting and auditing standards have in- Financial Executives creased in complexity. Auditors must continually As a professional group, financial executives have reassess the risk of a material misstatement in the long been aware of the need for skepticism, al- financial statements. though, like directors, they have no professional requirement to be skeptical. However, some Internal Auditors people may naturally have honed these skills. According to the Institute of Internal Auditors’ Prac- “Many of our top accountants had years in the tice Guide: Internal Auditing and Fraud, “Internal major accounting firms, where professional skep- auditors often play a critical role in the success or ticism is endemic. For our financial analysts, “You need failure of organizational fraud risk management. many of them came from top MBA programs, With their intimate knowledge of the workings of where effective analytical and communication to see an entity, internal auditors are in a unique position skills are taught,” says Gary Kabureck, vice presi- management to identify many of the indicators of fraud. When dent and chief accounting officer of and internal auditors act with skepticism and they focus chairman of the FASB Subcommittee at Finan- and how it on the effectiveness of internal controls, the likeli- cial Executives International. “While we cer- is relating to hood that they will notice the common character- tainly have a lot of technical training, a large part employees. istics of fraud is increased, and they might uncover of being financially skeptical comes from a perva- possible fraudulent activity if and where it exists.” sive ethical culture with required ethics training Where there As Richard Chambers, president and CEO of for everyone annually, including our CEO.” is smoke there the IIA, points out, “Skepticism can have a much Even before financial executives field questions is fire. If you broader definition for internal auditors because from others—such as the internal auditor, the our mission includes addressing a broad variety of audit committee and the external auditor—they hear something, risks—not just financial risks, but also operational must ask these skeptical questions of their data there is more. risks, compliance risks, and business and strategic sources. For example, if a CFO receives question- risks that organizations deal with every day.” able data points from a division president or from Ask, ‘Do the A focus on skepticism can also add to and im- his or her own staff, the CFO should not accept words and prove the skills on a team and ensure balance them at face value and wait for the internal au- the music go and perspective in internal auditing. ditor, audit committee or auditor to question the Paul Sobel, vice president and chief audit exec- results. Rather, he or she should take a proactive together?’” utive of Georgia-Pacific, suggests directors think position to investigate the situation. ­—William White about control as a “segregation of duties,” since Mandates aimed at financial statements have sometimes it is necessary to have more than one increased in recent years. Under Sarbanes-Oxley, person performing parts of a job, rather than re- CFOs are required to vouch for internal controls lying on an individual to perform the entire task. (Sections 302 and 404) and for financial statements “Without professional skepticism, an auditor (Section 906). Under the Dodd-Frank Act, execu- might trust that the control works, based on discus- tives face clawbacks of incentive pay awarded under sions with the individuals, but there’s always a pos- financial statements that are subsequently restated sibility that two or more employees could work to- (Section 954). It is more important than ever for gether to override the control,” Sobel explains. “So chief financial officers to make sure that others are a professionally skeptical auditor would investigate also honest. The skills of skepticism can help them or verify the control, rather than just trusting what not only do their own honest work, but also avoid they are told. In other words, a skeptical auditor negative consequences stemming from the possibly is not one who automatically doubts the control dishonest work of others.

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Mastering the Skill of Skepticism: A Six-Part Webinar Series Everyone involved in financial reporting—including external audi- that the information they receive is valid. Skepticism doesn’t mean tors, directors, financial executives and internal auditors—can work being mistrustful, playing devil’s advocate or asserting superior fi- more effectively if they can master the skill of professional skepti- nancial expertise. Rather, it means understanding the industry and cism. This does not mean a lack of trust. Rather, it means “I trust business, and applying business acumen. It also means insisting on you, but my responsibilities require me to confirm what you and logical responses to relevant questions. Common sense is a critical others tell me.” This “trust, but verify” approach is explored in a variable; sometimes the best questions come from the non-expert. video introduction and five 25-minute webinars posted (with full An effective board and audit committee can bring the best out in transcripts) on the NACD website at NACDonline.org/skepticism. external auditors, internal auditors and financial executives, as all parties grapple with important issues of accounting judgment. 1. Introduction by Michele Hooper, director, PPG Industries (audit committee chair), UnitedHealth Group (nominating and 5. Skepticism and the Financial Executive, with Marie Hollein, governance committee chair), NACD, Center for Audit Quality president and CEO, Financial Executives International; and governing board, and co-chair of the Anti-Fraud Collaboration. Greg Kabureck, vice president and chief accounting officer, Xerox Corp. 2. The Etiquette and Ethics of Skepticism, with Mary M. Financial executives find themselves on the receiving end of Mitchell, president, The Mitchell Organization; and William skepticism as they present financial reports and analysis to other White, director, NACD and ContextMedia, and professor, management, the board, the external auditors and others. But Northwestern University. these executives also need to exercise skepticism when it comes Asking “skeptical” questions can help directors and others get to the information flowing up to them through their organizations. to the bottom of things. But this can involve asking tough ques- Building a skepticism-ready team begins with hiring the right tions about sensitive topics. How can an individual exercise skepti- people, including executives with experience in conducting major cism without causing offense or weakening trust? The answer lies audits. It is also important to alleviate time pressure, which is a in proper etiquette as well as good manners and ethics. major motive for fraud, through good time management. Certifi- cation and attestation requirements under Sections 302, 404 and 3. Skepticism and the External Auditor, with Cynthia M. Fornelli, 906 of Sarbanes-Oxley help promote skepticism, because profes- executive director, Center for Audit Quality; and Gregory G. sionals won’t vouch for a report they don’t trust. The Committee Weaver, chairman and CEO, Deloitte & Touche. of Sponsoring Organizations’ five key areas—control environment, Financial statements are built on a series of accounting esti- risk assessment, control activities, information/communication and mates regarding transactions that can be extremely complex. monitoring—can become part of a reliable reporting system. So gathering audit evidence is a multistep process to get to the core of the estimate or transaction. As they exercise professional 6. Skepticism and the Internal Auditor, with Richard Chambers, judgment—from defining the right problem to documenting president and CEO, The Institute of Internal Auditors; and Paul their findings—external auditors approach their task with skepti- Sobel, , Georgia-Pacific. cism, a “questioning mind and a critical assessment of the audit Internal auditors are on the front lines of the fight against finan- evidence,” along with “presumptive doubt.” In exercising skep- cial reporting fraud. With their daily presence inside a company ticism, external auditors and others need to overcome natural and their constant focus on internal controls, internal auditors human judgment biases such as “confirmation,” “overconfi- are in a uniquely strong position to contribute to the deterrence dence,” “availability” and “anchoring.” and detection of fraud. But to be effective, they must adopt an attitude of skepticism. For internal auditors, as for external audi- 4. Skepticism and the Audit Committee, with Martin M. Coyne tors, skepticism means having a questioning mind, insisting on II, lead director and audit committee member, Akamai Technolo- evidence and having a mind-set that recognizes the possibility gies; and Ken Daly, president and CEO, NACD. of fraud. Only by having an independent as well as an appropri- Directorships are part time and subject to the inherent risk of ately and competently staffed internal audit capability can the asymmetric information, so directors need skepticism to ensure true value of internal audit be fully unlocked.

36 NACD Directorship January/February 2013 Additionally, the C-suite can focus on setting a skills, appropriate facial expressions and body lan- Ask the Right tone at the top that goes beyond the CEO giving guage, and exercising common courtesies. a speech or emailing employees a code of ethics. The ethical tone of an organization will both Questions “What we really need in practice is more tone from drive and reflect how it deals with employees, sup- the top, from the C-suite down and across the orga- pliers, customers and host communities. Ethics In judging the nization, to permeate throughout the organization, and skepticism go hand in hand—both involve a actions of people, to walk the talk by interfacing with staff, encour- search for the truth. to determine what is aging an open atmosphere where people can ask “Life is full of slippery slopes, and it is important to right, directors and questions of their managers if they have concerns,” know when you are approaching one,” says ­William professionals can ask a says Marie Hollein, president and CEO of Finan- White, former chairman and CEO of Bell & Howell, series of questions: cial Executives International. nonexecutive chair of ContextMedia, board member ■■ Is it legal? of NACD and a professor at Northwestern Univer- ■■ If so, is it moral? Etiquette and Ethics sity. “Once you are on it, it is too late. You will fall. ■■ If legal and moral, What can participants in financial reporting—­ And to see one of these coming you need all your what about its long- including board members—do to sharpen their senses. You need to see management and how it is term impact? skepticism? Asking tough questions can help di- relating to employees. Where there is smoke there is In all of these areas, rectors and others get to the bottom of things, but fire. If you hear something, there is more. Ask, ‘Do ethics and skepticism doing so can also put people on the defensive. How the words and the music go together?’ may be closely aligned. should an individual exercise skepticism without “The ethical tone of an organization is cu- causing offense or weakening trust? The answer mulative, resulting from many personalities and lies, at least in part, in proper etiquette and ethics. many actions, but a single individual can make a “You don’t have to be mean to be tough,” says difference,” White adds. Mary Mitchell, president of The Mitchell Organi- Everyone along the financial reporting chain can zation and the author of nine books on manners, help both deter fraud and detect it. To do so, it is including Class Act. important to distinguish facts from opinions and “Etiquette is a customary code of polite behavior values. Of the three, facts are likely the easiest to as- in society or among members of a particular pro- certain, White believes. One can agree to disagree fession or group—a set of rules one can learn,” when it comes to opinions, but values rise above sit- says Mitchell. It accords with good manners, an uational ethics, he notes. Directors and others need internal attitude based on respect and integrity. to make their own judgments and pay attention not Etiquette and manners create good relationships, just to what people say but also to what they do. which create good business, Mitchell believes. To be sure, there may be unethical skeptics FEI’s Hollein adds this wisdom: “When it comes or naïve ethicists, but these are the exception, to codes of ethics, the key is not just to sign a piece not the rule. White summarizes: “The skeptic of paper, but to really walk the talk and exercise is ethical—someone looking for the truth based skepticism by challenging what you see and hear, on evidence. And conversely, the ethical person not in a combative way, but a thoughtful way.” is skeptical—will be curious and looking for de- Studies by Harvard University, the Carnegie tails. So it’s hard to be effectively ethical without Foundation and the Stanford Research Institute exercising skepticism.” D have concluded that career advancement depends largely (85 percent) on interpersonal skills and For more information about the Anti-Fraud less (15 percent) on technical knowledge. Simi- ­Collaboration, visit antifraudcollaborationorg. For larly, a professional’s ability to exercise skepticism the webinar series, produced by Erin Essenmacher­ effectively depends in part on interpersonal skills. and Lia Temarantz of NACD Education and Key elements in any personal interaction include ­Alexandra R. Lajoux of NACD Research, see NACD a sense of setting, careful word choice, listening online.org/skepticism.

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