Much has been written about the unreliability of financial statements of firms in the UAE, audited or otherwise. This, according to bankers, has been the bane of lenders.
One can argue that this is hardly the sole cause of shoddy and negligent lending... but that is an argument saved for later. The largely unregulated audit industry in the UAE is neither bound by self-regulation nor tethered to any principles of accountability or responsibility.
The difference between a licensed and a regulated industry is starkly demonstrated here.
However, we cannot blame the auditors alone for dodgy financial reporting. Blame must be equally apportioned to business owners and CFOs responsible for producing management accounts that are audited by statutory auditors. In our experience of uncovering accounting and reporting frauds in the due diligence work we do for banks, it is always the pliant finance manager cooking the books in an overzealous demonstration of loyalty to the business owner, that is primarily responsible for a relatively “well-intentioned” misdemeanour morphing into a catastrophic fraud.
Misreporting’s several causes
Financial misreporting (or cooking the books) is rooted in several causes and usually starts on a small scale for a “good cause”, such as papering over a small loss or fall in sales or excessive dividends paid out and so on. This deleterious creativity is usually left entirely to finance managers or accountants who are left to “manage the situation” for the owner.
Creativity abounds and control slowly falls away as the situation becomes progressively grave and doctored statements become the basis of borrowing more and more from banks, often to finance losses or some other nefarious objective. The point of all this is that in all bankruptcies, skips and/or frauds, the blame falls squarely on business owners, with finance managers waltzing away nonchalantly to other jobs, almost completely absolved of all culpability.
A quick search online reveals copious text on the responsibilities or expectations of CFOs. Three principal requirements emerge.
- First, is a high level of integrity. CFOs are expected to be completely honest and transparent, to ensure quality information is generated and presented, in a fair and honest manner, in accordance with relevant process standards.
- Second, objectivity. CFOs are not expected to allow professional or business judgement to be over-ridden by bias, conflict of interest or the influence of others.
- Third, a high level of professional competence and due care, that mainly involves information/accounts produced to fairly represent the true performance and condition of their firm.
The legal and moral responsibilities of CFOs are coming under increasing scrutiny and the subject of intensifying regulation all over the world. In the US, the Dodd-Frank Act gives the SEC broad enforcement powers and raises the standards for internal controls. The SEC’s powers have therefore become daunting.
Prosecuting for recklessness
One example is that they can prosecute CFOs for recklessness, for a lack of “constructive knowledge” — that is, knowledge a CFO should have had by applying reasonable care or diligence, without having been actually aware of any wrongdoing. This is far reaching, because not only are wilful misconduct and/or incompetence now unforgivable, even ignorance of wrongdoing is inexcusable, if it is established that a CFO made inadequate or tepid efforts at becoming knowledgeable.
We are nowhere near reaching these standards of oversight in the region. Corporate governance is, to say the very least, in its infancy and needs to be taken up with alacrity by government.
Currently, oversight of companies, even listed ones is almost absent. Even institutions with systemic implications are not subject to stringent corporate governance standards. Which brings us to the crux of the issue — what of the SME sector?
In a market where auditors are not adequately regulated and corporate governance regulations are yet to be seen, what are lenders to do, as the main stakeholders to enterprises in the regional economy? Given that the bulk of the non-oil economy is dominated by SMEs — the definition is loose and can encompass firms up to a size of $500 million (Dh1.83 billion) in revenues — whose main finance providers are banks, how are lenders protecting themselves against malfeasance, loose or non-existent corporate governance and so on?
The sad truth is — absolutely nothing. The reasons for this state of inertness are many and complex. Amongst the many, some reasons are: intense competition amongst lenders, unwillingness of banks to talk to each other to set any form of common standard for any activity, lack of regulation, lack of initiative, etc.
Progress is always made one step at a time and it is time that the CFO/finance manager’s role is redefined by banks and responsibility ascribed to this community.
While owners are ultimately and solely responsible for misrepresentation, lenders ought to come together to ensure that CFOs are also in the dragnet. CFOs, for instance, should be required to sign declarations of fair and true representation of accounts of their firms, for a start.
Common standards of qualifications
Common standards of qualifications of CFOs should be agreed upon and enforced by lenders. If owners can be forced to sign personal guarantees to cover the borrowings of limited liability companies, or sign undated “security cheques”, then why are even the most basic of requirements — reliable and honest financial reporting — not expected of CFOs?
The development and imposition of corporate governance standards, whistle-blower policies, CFO responsibilities and so on is the responsibility of government. This will take time to come, but in the meantime, is status quo the answer?
Waiting for something is hardly an optimal solution. The only stakeholders who are the worst affected by financial misdemeanour, falsification of reporting and the like, are lenders. Therefore it is in their self-interest to urgently act and begin to address the chasm presented by lack of corporate governance in the region.
Vikram Venkataraman is managing director of Vianta Advisors.