MF Global – Management Overrides the Control System

Here is how MF Global describes itself on its web site:

“Indispensable, well-timed insight. Forward-thinking, unwavering vision. Deeply rooted passion for the markets. At MF Global, our relentless pursuit of market opportunity separates us from the pack and binds us in a common purpose—to help clients find an edge in today’s fast-paced, ever-evolving markets.

“Bringing together superior market access, well-timed market insights and powerful trading and hedging solutions. It’s our passion. And it’s why clients rely on MF Global to sharpen their edge in the world’s ever-changing markets.”

What a bunch of baloney!

Now it appears that Jon Corzine used the firm’s capital, and possibly the capital of his clients, to place bets on European bonds. He ignored the advice of other managers and senior executives by apparently circumventing the company’s system of internal control.

And MF Global broke the cardinal rule in this industry: it failed to segregate customer funds from its own working capital. Now MF Global clients may be out more than $1.2 billion.

Wall Street traders normally recognize they are in a high risk business. They often put in place a system of internal control designed to minimize the risk that a firm could place outsized bets that will put it out of business.

Those controls require a specific trading strategy to be approved by a series of oversight panels, including:

·         The Board of Directors

·         The Chief Executive Officer or President

·         The Head of Sales and Trading

·         The Chief Risk officer

·         The Trading Chief

·         The Risk Manager.

MF Global had an Audit and Risk Committee. The Audit and Risk Committee Charter included the following:

I. Purpose of the Committee

The purpose of the Audit and Risk Committee (the “Committee”) of the Board of Directors (the “Board”) of MF Global Holdings Ltd. (the “Company”) is to assist the Board in its oversight of:

·         the integrity of the Company’s financial statements and internal controls,

·         the Company’s compliance with legal and regulatory requirements,

·         the independent auditors’ qualifications and independence,

·         the performance of the Company’s internal audit function and independent auditors, and

·         the Company’s risk management policies, processes and profile.

IV. Committee Duties and Responsibilities

The Committee shall have the following duties and responsibilities:

With respect to risk management:

·         Review generally the overall enterprise risk management framework and related governance model and recommend to the Board approval of same.

·         Discuss the Company’s guidelines and policies that govern the risk management process.

·         Review periodically the Company’s major operational, financial, reputational, legal and compliance risk exposures and the steps management has taken to identify, assess, monitor and mitigate such exposures.

·         Receive regular independent reports from the Chief Risk Officer about the risk profile of the Company, against the risk appetite and risk tolerances adopted by the Board, and any reports on material breaches of related policy.

·         Review and provide advice to the Board’s Compensation Committee with respect to the compensation of the Company’s Chief Risk Officer.

VI. Performance Evaluation

The Committee shall conduct and review with the Board annually a performance evaluation of the Committee, which evaluation shall compare the performance of the Committee with the requirements of this charter. The performance evaluation shall also include a review of the adequacy of this charter and shall recommend to the Board any revisions the Committee deems necessary or desirable, although the Board shall have the sole authority to amend this charter. The framework for conducting the performance evaluation shall be established in such manner as the Nominating and Corporate Governance Committee deems appropriate.

(DRH: I’d love to see this evaluation!)

*********************

Despite all the right words written in its policies and procedures – the Board failed miserably. The normal oversight functions that are in place at other trading firms were ignored.

Mr. Corzine was the Chairman and Chief Executive Officer of MF Global – a bad decision. The Chairman is the head of the Board of Directors. The Board’s job is to oversee management. Management is headed by the Chief Executive Officer.

So, when the Chairman and the CEO is the same person – do you really believe effective oversight will occur??? 

Give me a break!

So Mr. Corzine traded $6.3 billion on European debt and talks only with the Board of Directors. He doesn’t follow the normal process which would have included the Chief Risk Officer. As we see time and again, management decides to override the system of control and the firm goes out of business and harms the financial interests of its shareholders and creditors.

In assessing control systems, we can see the wisdom of the Treadway Commission when it said the control environment (tone at the top) is the foundation of a control system.

It’s time for senior managers to recognize they are not necessarily the “smartest person in the room.” They need to adhere to a well thought out system of control, just as they expect all others to do.

Overriding the system of control is not a management right. It should only occur in extreme circumstances and only with the approval of the Board and other senior executives.

As we see in this example with MF Global, the words that are written and relied upon by others have no meaning when small minded managers decide the rules and values of a company do not apply to them.

dave@davehancox.com

Trying to Limit Audit Effort in Finding Medicaid Fraud

If you read the United States Code of Federal Regulations, you realize there are crazy rules that are designed to attempt to limit the ability of auditors to help the taxpayers.

The State Medicaid Fraud Control Units are designed to try and stop the billions of dollars in fraud that occurs each year in the Medicaid program. These units should be funded properly and staffed with competent employees aggressively seeking to stop the ripoff of taxpayer funds.

Under the Title 42 of the Public Health Code 1007.19 (e) (2) , the Federal government does not want to participate in paying for costs associated with efforts to identify situations in which a question of fraud may exist, including 

• the screening of claims, 
• analysis of patterns of practice, 
• or routine verification with recipients of whether services billed by providers were actually received

What a silly rule!

42 C.F.R. § 1007.19   Federal financial participation (FFP).
Title 42 - Public Health

PART 1007—STATE MEDICAID FRAUD CONTROL UNITS

§ 1007.19   Federal financial participation (FFP).

(a) Rate of FFP. Subject to the limitation of this section, the Secretary will reimburse each State by an amount equal to 90 percent of the costs incurred by a certified unit which are attributable to carrying out its functions and responsibilities under this part.

(b) Retroactive certification. The Secretary may grant certification retroactive to the date on which the unit first met all the requirements of the statute and of this part. For any quarter with respect to which the unit is certified, the Secretary will provide reimbursement for the entire quarter.

(c) Amount of FFP. FFP for any quarter will not exceed the higher of $125,000 or one-quarter of 1 percent of the sums expended by the Federal, State, and local governments during the previous quarter in carrying out the State Medicaid program.

(d) Costs subject to FFP. (1) FFP is available under this part for the expenditures attributable to the establishment and operation of the unit, including the cost of training personnel employed by the unit. Reimbursement will be limited to costs attributable to the specific responsibilities and functions set forth in this part in connection with the investigation and prosecution of suspected fraudulent activities and the review of complaints of alleged abuse or neglect of patients in health care facilities.

(2) (i) Establishment costs are limited to clearly identifiable costs of personnel that—

(A) Devote full time to the establishment of the unit which does achieve certification; and

(B) Continue as full-time employees after the unit is certified.

(ii) All establishment costs will be deemed made in the first quarter of certification.

(e) Costs not subject to FFP. FFP is not available under this part for expenditures attributable to—

(1) The investigation of cases involving program abuse or other failures to comply with applicable laws and regulations, if these cases do not involve substantial allegations or other indications of fraud;

(2) Efforts to identify situations in which a question of fraud may exist, including the screening of claims, analysis of patterns of practice, or routine verification with recipients of whether services billed by providers were actually received;

(3) The routine notification of providers that fraudulent claims may be punished under Federal or State law;

(4) The performance by a person other than a full-time employee of the unit of any management function for the unit, any audit or investigation, any professional legal function, or any criminal, civil or administrative prosecution of suspected providers;

(5) The investigation or prosecution of cases of suspected recipient fraud not involving suspected conspiracy with a provider; or

(6) Any payment, direct or indirect, from the unit to the Medicaid agency, other than payments for the salaries of employees on detail to the unit.

Doug Wood – A CPA Doing the Job Right in Malone New York!

One of my last audits in the New York State Comptroller’s Office was of a not-for-profit, Community Action Agency in Franklin County that is primarily funded by New York State and federal grants.

This is a good audit to review because the auditors appropriately assessed the control environment component of the COSO framework for internal controls.

But it also highlights the good work of a local CPA who had the courage to stand up and not be intimidated by the management of the organization. 

For his courageous act – he was fired.

As stated in the audit report:

“Another example of the poor control environment at ComLinks involved Ms. Reich’s firing of an independent CPA. Federal Circular OMB-A-133 requires not for profit entities who expend more than $300,000 annually to have a single audit done of their financial statements. To be compliant with this regulation, ComLinks initially hired Mr. Doug Wood, CPA to perform their single audit. For the year ending September 30, 2006, Mr. Wood was going to issue a report with a qualified opinion about ComLinks financial statements because he questioned numerous adjustments and reallocations of costs among grants; identified late payment charges, and delay of revenue causing serious cash flow issues; and noted missing supporting invoices. According to Mr. Wood, Ms. Reich asked Mr. Wood to change his opinion from qualified to unqualified. In return, Ms. Reich made an inappropriate offer to Mr. Wood. Mr. Wood declined the offer and Ms. Reich fired him.”

I commend Doug Wood for having the courage to do right according to his professional responsibilities. He is a hero and I encourage all of the people in the northern part of New York State to visit Doug for their accounting and tax work.

You can read the audit report and find out about other professionals, including another CPA, who failed in carrying out their professional responsibilities.

The downward slide of East Greenbush, New York

I became interested in the East Greenbush, New York government after a concerned citizen contacted me and presented me with evidence of wrong-doing that needed further investigation. 


This person had contacted the Governor's Office, the State Comptroller's Office, and the State Police. The State Police advised the informant there was credible evidence, but the District Attorney would not act until the State Comptroller's Office acted. 


The State Comptroller's Office has not responded to several letters the informant provided to them.


I've since reviewed the 2009 audit of the East Greenbush financial statements. The 2010 audit is not completed because East Greenbush has fired the prior auditor and hired a new auditor. 


Getting up to speed for the new auditor takes some time and the prior audit identified some significant internal control issues that further speak to the problems identified by the concerned citizens.


Here's what I found:

• The 2009 financial statements had a qualified audit opinion - meaning the financial statements did not present fairly the financial position of East Greenbush. Specifically it said
• "..., the financial statements present only the general fund, special revenue funds, and capital projects fund and do not purport to, and do not, present fairly the governmentwide financial position of the Town of East Greenbush, New York as of December 31, 2009, and the government-wide changes in its financial position and budgetary comparisons for the year then ended in conformity with accounting principles generally accepted in the United States of America."
• There were material deficiencies in the system of internal control. Specifically, 
• Significant accounting and reconciliation entries are required to adjust the December 31, 2009 Annual Update Document. A more timely and complete reconciliation and document review should be developed, implemented and monitored to ensure and maintain a more effective accounting, reconciliation and reporting infrastructure. The general ledger system is currently platformed on a Microsoft Access Database, which lacks access and modification controls and contributes to an increased risk for potential error or misstatement. Our observation of the Town of East Greenbush’s current accounting, reconciliation and reporting process indicates that it does not support the Town’s needs and long-term commitment to strong internal control. 
• There were significant deficiencies in the system of internal control. (significant is a term of art meaning not up to the level of a material deficiency, yet important enough to merit attention by those charged with governance.) Specifically, 
• There is no systematic method of ensuring that timely and complete monthly reconciliation and closing procedures take place. Accounts receivable, accounts payable, compensated absences, payroll and others were not reconciled on a systematic basis. 
•  No supervisory review of accounting transactions and month end reconciliations is performed. This allows errors to exist within the books of account, and without subsequent correction they could continue to grow in magnitude.
• There is a lack of segregation of duties within the cash receipts area in the Town Clerk’s office. One employee is responsible for receiving, maintaining records and depositing cash. There is a lack of segregation of duties within the payroll area. One person is responsible for preparing payroll input, entering new employee information, removing terminated employees, reviewing the payroll data as well as distributing payroll checks. There is a lack of segregation of duties within the accounting area. One person is responsible for recording cash receipts, cash disbursements and other related adjusting entries, reconciling cash accounts, as well as having the ability to generate checks with electronic signature. There is also a lack of segregation of duties within the purchasing area. One person has the ability to initiate the purchase order, record the purchase order as well as generate the check for the purchase. The combination of duties in each area indicated above is incompatible and significantly decreases the chance of an error or irregularity being detected on a timely basis.
• There is no formal process of comparing the periodic budget to actual revenues and expenses by senior management. In 2009, the Town has incurred substantial variances between the budget and actual revenues and expenses without adequate documentation of reasons for the variances.
• The Town’s purchasing policy requires an approved purchase order with at least two verbal/FAXed quotes for purchases over $300 to $2,999 for General and $1000 to $2,999 for Highway, and with at least three written/FAXed quotes for purchases over $3,000 to $9,999. During the year ended December 31, 2009, we noted certain purchases with the total amount of approximately $44,000 did not follow the purchasing policy or lacked adequate documentation under the policy as outlined in the Town’s purchasing policy. 
• During the year ended December 31, 2009, supplementary compensation was paid to certain employees in addition to their regular salary. There was no formal process of comparing payroll records to approved salaries.  

Moody's Investors Service

The significance of these issues is reflected in the declining credit rating East Greenbush has been receiving from Moody's Investors Service on its General Obligation Bonds. The following chart is instructive:


According to Moody's:

The Ba1 rating reflects the town's depleted financial position after a multi-year trend of operating deficits resulting in a fiscal 2009 General Fund balance equal to negative 22.7% of General Fund revenues. The Ba1 rating balances the town's depleted financial position against a moderately sized $1.9 billion tax base and above average socio-demographic profile.

Rating date	Rating	Rating Type	Action
01 Mar 2011	Ba1	Underlying	RATING AFFIRMATION
16 Apr 2010	Ba1	Insured	Change in Scale
16 Apr 2010	Ba1	Underlying	Change in Scale
10 Dec 2009	Ba1	Underlying	DOWNGRADED
10 Dec 2009	Ba1	Insured	DOWNGRADED
13 Apr 2009	A3	Insured	RATING AFFIRMATION
03 Mar 2009	A3	Insured	RATING AFFIRMATION
05 Nov 2008	A3	Insured	DOWNGRADED
18 Sep 2008	Aa3	Insured	Possible Downgrade
19 Jun 2008	Aa3	Insured	DOWNGRADED
04 Jun 2008	Aaa	Insured	Possible Downgrade
12 Mar 2008	Aaa	Insured	CONFIRMED
16 Jan 2008	Aaa	Insured	Possible Downgrade
09 Apr 2002	Aaa	Insured	NEW

Here is the rating scale used by Moody's:

Aaa  - Highest Rating

Aa

A.

Baa

Ba

B

Caa

Ca

C  - Lowest Rating

Note: Moody's appends numerical modifiers 1, 2, and 3 to each generic rating category from Aa through Caa. The modifier 1 indicates that the issuer or obligation ranks in the higher end of its generic rating category; the modifier 2 indicates a mid-range ranking; and the modifier 3 indicates a ranking in the lower end of that generic rating category.

So Back to the Original Complaint


Interestingly, the prior auditors identified the issue of certain town employees receiving supplementary compensation without appropriate controls over its payment - as was initially identified by the concerned citizens.


As I originally reported:

For example, one town employee was paid over $170,000 to be a “town consultant.” The person submitted vouchers for the supposed work done, but was not paid as an independent contractor. Instead, he was paid as an employee. On the surface, something is fundamentally wrong with this.

If you’re a consultant, unless you have some special expertise that justifies a sole source contract, this work should have been competitively bid.

More importantly, favored individuals shouldn’t be getting government business. State and municipal law require all vendors get a fair opportunity to get government’s business.

But why pay him as an employee and incur additional payroll costs? The less expensive way is to pay him as the independent contractor he seemed to be from the vouchers he submitted (employees don't submit vouchers, contractors do).

The town incurred additional payroll taxes and pension contributions that were unnecessary by paying him as an employee.


The Solution


It's clear the agencies with oversight responsibility have fallen down on the job. 


Hopefully, the voters of East Greenbush recognize the job now is in their hands. They need to vote for people who will recognize accountability for government resources is the responsibility of the elected officials entrusted with tax dollars.


East Greenbush residents deserve better than what is now happening.

Update - The Bureaucratic Shuffle – potential fraud in East Greenbush, New York government

The concerned citizens of East Greenbush, New York still have not received a response to the letters they have sent to the control agencies in New York State.

http://davehancox.blogspot.com/2011/09/bureaucratic-shuffle-potential-fraud-in.html

Isn't that too bad.

Why do Auditors Write Like Idiots?

Here is an interesting audit by the City Auditor of Palo Alto, California.

http://www.cityofpaloalto.org/civica/filebank/blobdload.asp?BlobID=28985

It’s a detailed audit on an important topic, but unfortunately, most people are not going to read it.

If they do read it, most people won’t understand it.

And that’s too bad.

The report is 80 pages long and the conclusion is on the 59^th page. Here’s the conclusion from the audit report:

“The City’s SAP Enterprise Resource Planning system supports its core business functions and management of information. An unsecured system-provided SAP user account with unrestricted access resulted in a significant security vulnerability, and ASD violated two critical security principles by not properly restricting access for all user accounts. Moreover, ASD has not formally adopted and implemented all controls needed to effectively manage SAP user accounts to ensure system security. The Auditor’s Office recommends formal adoption of the PCI DSS and NIST SP 800-53 security control frameworks and further security assessments of the City’s information systems using a risk-based approach.”

First, this jargon just has to go (PCI DSS, NIST SP 800-53). We need to write in plain English. I was responsible for managing a group of computer auditors and they kept telling me, “You just didn’t understand – this is how we talk.”

They’ve got to get a grip and write so the City Manager and his or her staff can understand what is happening.

Second, the writers of this report need to be sure they are saying what really is going on. “An unsecured system-provided SAP user account with unrestricted access resulted in a significant security vulnerability.”

While that is hard to understand as written – I’ll bet the writer meant to say the opposite of what was written. The security vulnerability resulted in access to a SAP user account.

Third, ASD (whatever that is) doesn’t do anything. People do.

So, who specifically violated two critical security principles and why are they not held accountable for their actions in this audit report? Too often, auditors are cowards and are unwilling to point to the real cause of the problems in an organization.

Writing is a difficult task. Unfortunately, the most critical part of an audit – communicating the results, is often left to people who have not studied the craft of writing.

Too many auditors approach the task of writing without tools – such as a book on grammar or a book on style. They don’t even have a dictionary, thesaurus or a book of synonyms.

There are many good books on writing. But one of the best is short and to the point - The Plain English Approach to Business Writing by Edward P. Bailey Jr. It’s an investment worth making if you write audit reports.

And if that book doesn’t help you, buy, Why Business People Speak Like Idiots: A Bullfighter's Guide.

If you want to be an amateur you don’t have to study the craft of writing. If you want to be a real professional though – you've got to be on your game and be a good writer.

This was a good audit and the auditors deserve credit for raising an important issue. They just need to improve the approach to presenting the information to management and to the public.

Auditor Stands Firm - and Quits!

Here is an interesting battle between an audit firm and an audit client. I'm pleased to see an audit firm stand up for its independence.

Good for Ernst and Young!

The is from the 8-K form and the exhibits.

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 8-K

 

 

CURRENT REPORT PURSUANT

TO SECTION 13 OR 15(D) OF THE

SECURITIES EXCHANGE ACT OF 1934

 

 

Date of report (date of earliest event reported):  June 6, 2011

 

LIFE PARTNERS HOLDINGS, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

 

Texas

(State of incorporation)

0-7900 (Commission File Number)	74-2962475 (I.R.S. Employer ID no.)
204 Woodhew Waco, Texas (Address of Principal Executive Offices)	76712 (Zip Code)

 

Issuer’s telephone number, including area code:  254-751-7797

 

 

Check the appropriate box below if the Form 8-K filing is intended to simultaneously satisfy the filing obligation of the registrant under any of the following provisions (see General Instruction A.2. below):

 

o

Written communications pursuant to Rule 425 under the Securities Act (17 CFR 230.425)

 

o

Soliciting material pursuant to Rule 14a-12 under the Exchange Act (17 CFR 240.14a-12)

 

o

Pre-commencement communications pursuant to Rule 14d-2(b) under the Exchange Act (17 CFR 240.14d-2(b))

 

 o         Pre-commencement communications pursuant to Rule 13e-4(c) under the Exchange Act (17 CFR 240.13e-4(c))

 

 

 

---

 

 

Item 4.01. Changes in Registrant’s Certifying Accountant

 

On June 6, 2011, Life Partners Holdings, Inc. (“we” or “Life Partners”) received a letter from Ernst & Young LLP (“Ernst & Young”) addressed to the Chairman of our Audit Committee (the “Resignation Letter”) confirming that it had resigned effective June 3, 2011, as our independent registered public accounting firm, as had been orally communicated to the Chairman of the Audit Committee on June 3, 2011.  The resignation means that Ernst & Young will not certify our financial statements for the fiscal year ended February 28, 2011 (“Fiscal 2011”), which is necessary for completing and filing our Annual Report on Form 10-K for Fiscal 2011 (the “2011 Annual Report”).

 

The resignation follows a letter from Mr. Brian Pardo, our Chairman and CEO, to our licensee network (persons who refer purchasers to us) commenting upon the delayed filing of our 2011 Annual Report.  The letter stated that it was Mr. Pardo’s position that we would “take action” against Ernst & Young if it did not promptly complete its audit and sign off on our financial statements without adjustment.  Our Audit Committee wrote to Ernst & Young disclaiming the letter’s statements and asserting that the letter did not speak for the Audit Committee.  Notwithstanding the Audit Committee’s disclaimer, Ernst & Young stated that the letter compromised its independence, and when considered with other recent developments, that it was no longer able to rely upon management’s representations, and that it was unwilling to be associated with the financial statements prepared by management.

 

In its Resignation Letter, Ernst & Young further stated that after a re-examination of our revenue recognition policy, it had concluded that we should revise the policy.  Our existing policy recognizes income at the time a settlement has been closed (that is, an agreement has been reached with the settlor and the purchaser has obligated itself to make the purchase).  Ernst & Young believes that revenues should be recognized no earlier than the final closing of escrowed funds with the settlor.   Ernst & Young also stated that some portion of our fee revenue should be allocated and deferred based the Company’s practice of making premium advances.  It further concluded that the use of our current accounting policies and practices with respect to these matters results in a more than remote likelihood that a material misstatement in our annual and interim financial statements could occur and not be prevented or detected by our internal controls (which are based on existing policies).

 

The revenue recognition matter constitutes a disagreement as defined under Item 304(a)(1)(iv) of Regulation S-K, as promulgated by the Securities and Exchange Commission (the “SEC”).  Ernst & Young discussed the subject matter of the disagreement with our Audit Committee and our Chief Financial Officer.  We have authorized Ernst & Young to respond fully to any successor independent registered public accounting firm that the Audit Committee appoints.

 

We engaged Ernst & Young as our independent registered public accounting firm on March 2, 2010, and it had expressed an unqualified opinion on our Fiscal 2010 financial statements.  Ernst & Young followed Eide Bailly LLP (“Eide Bailly”), which had been our independent registered public accounting firm, which audited our Fiscal 2009 financial statements, and which expressed an unqualified opinion on such statements.  Except as described above, during the two most recent fiscal years and interim period preceding Ernst & Young’sresignation, there were no other disagreements with either Ernst & Young or Eide Bailly as defined under Item 304(a)(1)(iv) of Regulation S-K and no other reportable events with either firm as defined under Item 304(a)(1)(v) of Regulation S-K.  While not a reportable event, our report on internal controls and Eide Bailly’s opinion on internal controls include information related to material weaknesses in our internal controls, which were included in our Form 10-K for the year ended February 28, 2009.  The material weakness was unrelated to the matters cited as disagreements by Ernst & Young.

 

We provided Ernst & Young with a copy of this Current Report on Form 8-K and asked that Ernst & Young furnish us with a letter addressed to the SEC stating whether it agrees with the above statements.  The Resignation Letter is attached as Exhibit 7.1.  Ernst & Young’s letter dated June 9, 2011, addressed to the SEC is attached as Exhibit 16.1.