Securities Authority Report Slams Internal Audits at Publicly Traded Firms

Harsh comments were found in a report evaluating the scope of internal auditing at companies traded on the Tel Aviv Stock Exchange.

"Serious findings," "A whitewash of internal auditing," and "internal auditing that is little more than an organizational ornament," are some of the harsh comments found in the report evaluating the scope of internal auditing at companies traded on the Tel Aviv Stock Exchange.

The report, compiled by the Institute of Internal Auditors, the Israel Securities Authority (ISA) and Bar-Ilan University, decries the inadequacy of internal auditing at publicly traded companies - despite the companies' legal obligations in this area.

"What they call 'internal auditing' is nothing but empty lip service and an organizational ornament with nothing behind it," states the report.

Even worse, the firms' reports to the ISA concerning their internal auditing are suspected of being unreliable. The report recommends the creation of a tracking mechanism and review by the recognized authorities, "in order to verify and confirm the accuracy of the data the companies submit to the ISA; whether the figures are valid or concocted to satisfy the receiver," that is, the ISA.

The serious allegation that the publicly traded companies' reports are unreliable was raised following incongruities in the reports relayed to the ISA by the companies concerning the internal auditing they conduct. In the wake of the Enron scandal in the United States earlier in the decade, the ISA began requiring publicly traded companies to step up their internal auditing and provide it with a detailed annual report of the auditors' work.

The current report examined the internal auditing reports submitted by 500 publicly traded companies for the years 2004, 2005 and 2006. Now here's the strange part: Those reports show that the companies' boards of directors greatly appreciated the usefulness of the internal auditing. In fact, a whopping 86% reported their satisfaction with their internal auditors' work.

How is one to reconcile this puzzling level of satisfaction with the grave findings on the scope of the internal audits?

The overwhelming majority of publicly traded companies (84%) do not employ a full-time internal auditor, but rather hire the services of external accounting firms.

The average number of hours for which the companies paid for internal auditing is quite low, with 87% of the companies reporting about 10 hours a week, on an annual basis. As for the number of reports produced by these auditors, 28% of the companies offered no figure at all. Among the companies that did indicate the number of internal auditing reports prepared, 83% issued just 3 reports a year - fewer than one per quarter.

"The small number of reports prepared by the companies does not reflect the proper or required level of auditing and does not meet a reasonable minimum of at least one report per quarter," claim the report's writers.

"These figures refer to 50% of the companies with a market value of over NIS 100 million and 36% of the companies valued at between NIS 100 million and NIS 1 billion. These are medium and large companies capable of independently conducting proper internal auditing."

The fact that companies reporting a small number of internal auditing hours also reported high satisfaction with this auditing is also scathingly criticized by the report.

"The high satisfaction reported by the companies is not compatible with the minimal and insufficient findings from the number of auditing reports produced, and the number of auditing hours purchased by the companies," continues the report.

The report's authors recommend that written procedures be instituted for the internal auditing at publicly traded companies, including the imposition of sanctions against companies that do not stick to the procedures.

The authors also recommend legislating specific auditing requirements at publicly traded companies, which would include enforcement powers for the ISA, so that it could check the veracity of the reports, obligate companies to employ a full-time internal auditor and institute licensing for internal auditors, including sanctions to revoke the licenses of internal auditors who do not meet their obligations.