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FCPA Compliance Report

Tom Fox has practiced law in Houston for 30 years and now brings you the FCPA Compliance and Ethics Report. Learn the latest in anti-corruption and anti-bribery compliance and international transaction issues, as well as business solutions to compliance problems.
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Jul 23, 2017

This week we turn our attention to COSO, with an introduction to the organization and its framework for internal controls. I will go through the internal controls and how they relate to compliance. Finally, I will end with a discussion of evaluation of internal controls through the COSO Framework. Once again, I am joined in this exploration by internal controls and accounting expert Joe Howell, EVP at Workiva, Inc. 

What is COSO? That acronym stands for Committee of Sponsoring Organizations of the Treadway Commission, which originally adopted in 1992, as a framework for basis to design and then test the effectiveness of internal controls. It was deemed necessary to update this more than 20-year old COSO Framework, to provide a more supportable approach when adversarial third parties challenge whether a company has effective internal controls (such as the SEC). While the COSO Framework is designed for financial controls, I believe that the SEC will use the 2013 Framework to review a company’s compliance internal controls. This means that you need to understand what is required under the 2013 Framework and can show adherence to it or justify an exception if you receive a letter from the SEC asking for evidence of your company’s compliance with the internal controls provisions of the FCPA. 

COSO has produced three volumes detailing the 2013 Framework. The first lays out the Framework and is entitled “Internal Control – Integrated Framework”, herein ‘the Framework volume’. The second is an Illustrative Guide, entitled “Internal Controls – Integrated Framework, Illustrative Tools for Assessing Effectiveness of a System of Internal Controls”, herein ‘the Illustrative Guide’, which discusses how best to assess your internal control regime and provides forms and work sheets to use in this exercise. The third volume is the Executive Summary of the first volume, herein ‘Executive Summary’. All three works form an excellent starting point for exploration of the COSO Framework and how you might use it for your best practices anti-corruption compliance program. 

In the 2013 update the basic framework was retained with substantial support from user companies, and 3 specific objectives were added: (I) Operations Objectives – effectiveness and efficiency of operations, including safeguarding assets against loss; (II) Reporting Objectives – internal and external financial reporting; and (III) Compliance Objectives – adherence to laws and regulations to which the entity is subject. According to the guidance in the 2013 update, the system of internal controls can be considered effective only if it provides reasonable assurance the organization, among other things, complies with applicable laws, rules, regulations and external standards. With the addition of those specific objectives, the COSO framework now specifically includes the need for controls to address compliance with laws and regulations. 

The COSO Framework defines internal controls, from bottom to top, with the following Objectives: (a) Control Environment, (b) Risk Assessment, (c) Control Activities, (d) Information and Communication, and (e) Monitoring. From these five Objectives come 17 Principles which we will be exploring throughout this series. 

Larry Rittenberg, in his book “COSO Internal Control-Integrated Framework”, said that the original COSO framework from 1992 has stood the test of time “because it was built as conceptual framework that could accommodate changes in (a) the environment, (b) globalization, (c) organizational relationship and dependencies, and (d) information processing and analysis.” Moreover, the updated 2013 Framework was based upon four general principles which include the following: (1) the updated Framework should be conceptual which allows for updating as internal controls [and compliance programs] evolve; (2) internal controls are a process which is designed to help businesses achieve their business goals; (3) internal controls applies to more than simply accounting controls, it applies to compliance controls and operational controls; and (4) while it all starts with Tone at the Top, “the responsibility for the implementation of effective internal controls resides with everyone in the organization.” For the compliance practitioner, this final statement is significant because it directly speaks to the need for the compliance practitioner to operationalize internal controls for compliance and not to simply rely upon a company’s accounting, finance or internal audit function to do so. 

The primary object is to keep in mind that even if an organization adopts the Framework, there will be very few people within that organization who will have the unique knowledge that a compliance officer has that would impact all the elements of the Framework. The compliance officer's role is to provide the input to the Chief Financial Officer (CFO) and others involved in the implementation, to be sure that there is a proper focus on the risks that really are part of the compliance world. This primarily comes through the risk assessment component, the control activities, and then the monitoring. Companies typically do risk assessment from an operational standpoint and address business risks going forward and then develop the controls that deal with those business risks, which could be project financial results, doing business in certain countries, strategic decisions and similar issues. All of this puts the compliance function in the unique position to be the fulcrum on many issues which will come up with a COSO based analysis or implementation. 

The updated Framework retained the core definition of internal controls; those being control environment, risk assessment, control activities, information and communication, and monitoring activities. Further, these five operational concepts are still visually represented in the well-known three-dimensional “COSO Cube”. In addition, the criteria used to assess the effectiveness of an internal control system remain largely unchanged. The effectiveness of internal control is assessed relative to the five components of internal controls and the underlying principles supporting the components. However, it is the emphasis on the principles, which is new to the 2013 Framework. 

Joe Howell noted that the COSO Framework can be seen as both a prevent and detect control.  He also related that your internal controls need to be sustainable over the long haul. He stated, “You cannot just build one off things that allow you to do one period and not have a process in place that is going to help you through all of the periods that you need to cover. The controls cannot just be a one and done. Many companies are going to find that their initial approach to all of this is one and done.” As we explore the COSO Framework, the compliance practitioner should understand how the entire Framework interacts and intersects with the compliance function in a manner which is sustainable throughout the organization. 

Three Key Takeaways

  1. You must use the COSO Framework or a similar source for your internal controls structure.
  2. The 2013 Framework identifies the following areas: (a) Control Environment, (b) Risk Assessment, (c) Control Activities, (d) Information and Communication, and (e) Monitoring.
  3. Your internal controls must be sustainable.

For more information on how to improve your internal controls management process, visit this month’s sponsor Workiva at workiva.com.

 

 

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