CFOs face in­creased li­a­bil­ity risk

Be­ing a CFO has tra­di­tion­ally been re­garded as a top- end job. But changes in leg­is­la­tion mean that CFOs now face per­sonal li­a­bil­ity un­der the Com­pa­nies Act, sig­nif­i­cantly de­creas­ing the at­trac­tive­ness of the job. RISKSA ex­am­ines the is­sues.

RISKSA Magazine - - CONTENTS - Neesa Mood­ley- Isaacs

The Com­pa­nies Act of 2008, the Con­sumer Pro­tec­tion Act and the Pro­tec­tion of Per­sonal In­for­ma­tion Bill have all raised the bar for chief fi­nan­cial of­fi­cers in that the risk of per­sonal lit­i­ga­tion against com­pany di­rec­tors and of­fi­cers is more preva­lent than ever be­fore.

The Com­pa­nies Act, which now gov­erns all cor­po­rate en­ti­ties in South Africa, adopts a stake­holder ap­proach as op­posed to a share­holder ap­proach, with the term ‘ stake­holder’ now en­com­pass­ing a much wider group in­clud­ing, among oth­ers, em­ploy­ees, cred­i­tors and the en­vi­ron­ment.

One of the key is­sues raised by the new act is that of di­rec­tor li­a­bil­ity and the per­cep­tion that di­rec­tors now have greater per­sonal li­a­bil­ity. “The new Com­pa­nies Act has, to a large ex­tent, de­crim­i­nalised trans­gres­sions, but it has also cod­i­fied the old com­mon- law du­ties of di­rec­tors,” says Larey van der Westhuizen, man­ag­ing di­rec­tor of Statu­cor, the com­pany sec­re­tar­ial and cor­po­rate gov­er­nance arm of the BDO Group.

“Their duty is now to­wards the com­pany, with most of their li­a­bil­i­ties be­ing for losses that the com­pany has suf­fered. The new act has also in­tro­duced sol­vency and liq­uid­ity tests as a re­place­ment for the old cap­i­tal main­te­nance rule.”

Van der Westhuizen says there is a need to de­ter­mine who is a pre­scribed of­fi­cer in an or­gan­i­sa­tion. This is a new term in­tro­duced by the act, which ap­plies to people who are in ex­ec­u­tive po­si­tions, but who are not di­rec­tors, yet have the same du­ties and li­a­bil­i­ties as di­rec­tors.

In­crease in re­ported fraud

Ac­cord­ing to the third KPMG Fraud Barom­e­ter study, South Africa has the high­est num­ber of re­ported fraud cases on the African con­ti­nent. The study shows that there has been an in­crease in the num­ber of fraud cases be­ing re­ported.

“In South Africa, for­eign in­vestors and South African com­pa­nies in­vest­ing on the African con­ti­nent are in­creas­ingly con­scious of multi­na­tional and na­tional anti- fraud

leg­is­la­tion. They un­der­stand that not play­ing by the rules can have a sig­nif­i­cant im­pact on mar­ket cap­i­tal­i­sa­tion and are there­fore more ac­count­able when it comes to fraud and cor­rup­tion,” says Petrus Marais, KPMG’s global leader of foren­sics.

“We also see a num­ber of en­force­ment agencies, such as the Na­tional Pros­e­cut­ing Author­ity of South Africa, work­ing hard to bring per­pe­tra­tors to jus­tice. Prose­cu­tion is in­creas­ing but still re­mains low com­pared to re­ported cases. We do note im­prove­ment, but also un­der­stand that it may take more time.”

Catch 22

Ter­tia Bar­rett, head of sales and mar­ket­ing at CQS Tech­nol­ogy Hold­ings, says fraud is not limited to larger cor­po­ra­tions but has also mush­roomed in smaller com­pa­nies. “The Com­pa­nies Act changed the re­quire­ments stat­ing which com­pa­nies need to be au­dited. So, smaller com­pa­nies no longer need to be au­dited. Al­though this move was in­tended to re­duce the cost of do­ing busi­ness in South Africa, it has opened the door for fraud­u­lent ac­tiv­ity,” she says.

“A chief fi­nan­cial of­fi­cer ( CFO) can now be held per­son­ally li­able for fraud be­cause he signs off on all fi­nan­cial state­ments. So, it’s a catch 22 sit­u­a­tion – not all com­pa­nies need to be au­dited and the CFO now risks per­sonal li­a­bil­ity,” Bar­rett ex­plains.

Bar­rett says ac­coun­tancy train­ing is still too ba­sic with in­suf­fi­cient fo­cus on in­ter­nal au­dit­ing and fraud preven­tion tac­tics. The South African In­sti­tute of Char­tered Ac­coun­tants ( SAICA) has stepped in to pro­vide train­ing. “Re­duc­ing the risk of fraud out­weighs the cost of the train­ing,” Bar­rett says.

Reg­u­la­tion and com­pli­ance a con­cern

Re­search by ac­count­ing firm, Ernst and Young, shows that the per­cent­age of board mem­bers with a fi­nance back­ground has in­creased sig­nif­i­cantly over the past 12 years.

In 2002, for ex­am­ple, just eight per cent of board mem­bers at some of the world’s largest com­pa­nies were ei­ther cur­rent or for­mer

CFOs. By 2012, that fig­ure had climbed to 12 per cent. In 2002, just 19 per cent of au­dit com­mit­tee chairs were ex­pe­ri­enced CFOs. By 2012, this had risen to 41 per cent.

One of the main rea­sons for the change is chang­ing reg­u­la­tory re­quire­ments in dif­fer­ent coun­tries. Gra­ham Stockoe, Ernst and Young’s Africa Pri­vate Eq­uity leader, says: “For CFOs of African com­pa­nies, we ex­pect more fo­cus on reg­u­la­tion and com­pli­ance as this area rapidly evolves with con­tin­ued fo­cus on how the CFO and their fi­nan­cial team can add value to in­vest­ment pro­fes­sion­als and the firm’s port­fo­lio com­pa­nies. How­ever, Ernst and Young found that 45 per cent of CFOs across the world put reg­u­la­tion and com­pli­ance at the top of their list of con­cerns for 2014. They ( CFO) also said the in­creased reg­u­la­tory de­mands had put a strain on their firms’ re­sources and had limited their abil­ity to fo­cus on key pri­or­i­ties. As a re­sult of reg­u­la­tory changes, 83 per cent of CFOs ex­pect to see an in­crease in costs.

Are CCs on the way out?

The act raises the ques­tion whether there is any ben­e­fit in keep­ing close cor­po­ra­tions ( CC). “I don’t think there is any ben­e­fit in keep­ing CCs and my ad­vice would be to con­vert them to pri­vate com­pa­nies,” Van der Westhuizen says. “The same rules ap­ply to both, but in a CC all mem­bers have the li­a­bil­i­ties of a di­rec­tor; it is not pos­si­ble to be an owner in a CC with­out also be­ing re­garded as in­volved in man­age­ment. A com­pany pro­vides that op­por­tu­nity by sep­a­rat­ing share­hold­ers from di­rec­tors. Also, a CC al­ways has 100 per cent of in­ter­est is­sued, and the only way to ac­quire an in­ter­est in an es­tab­lished CC is by ac­quir­ing it from an ex­ist­ing mem­ber. A com­pany can is­sue more shares and raise cap­i­tal by do­ing so.”

On the sub­ject of the Me­moran­dum of In­cor­po­ra­tion, Van der Westhuizen ex­plained the im­por­tance of pre­par­ing this cor­rectly. “This is ef­fec­tively the doc­u­ment in which a com­pany tai­lor- makes the cor­po­rate gov­er­nance prin­ci­ples and rules that will ap­ply to them by al­ter­ing the de­fault terms of the act ca­pa­ble of amend­ment. In do­ing so a com­pany makes use of the op­por­tu­ni­ties and ben­e­fits pro­vided by the new act en­sur­ing that it suits their spe­cific needs. It is es­sen­tial that this doc­u­ment is pre­cise and that it in­cludes the cor­rect ter­mi­nol­ogy to avoid prob­lems down the line.”

So­lu­tions

Bar­rett says pur­pose- writ­ten soft­ware can pro­vide a so­lu­tion. “Soft­ware with a built- in au­dit trail and drill- down func­tion­al­ity can al­low a CFO to in­ter­ro­gate ev­ery fig­ure on a fi­nan­cial state­ment,” she says. Li­a­bil­ity in­sur­ance can in­dem­nify di­rec­tors and of­fi­cers against claims

for which they are legally li­able, as a re­sult of an in­no­cent act, omis­sion or er­ror in judg­ment. This type of in­sur­ance can cover CFOs’ costs in the fol­low­ing in­stances: Civil or crim­i­nal de­fence costs Le­gal rep­re­sen­ta­tion ex­penses

• Dam­ages

• Judg­ments

• Set­tle­ments

• A writ­ten de­mand ( whether or not for mon­e­tary com­pen­sa­tion)

• A for­mal ad­min­is­tra­tive or reg­u­la­tory pro­ceed­ing or an ar­bi­tra­tion pro­ceed­ing

• Mis­rep­re­sen­ta­tion or mis­man­age­ment

• Breach of fidu­ciary duty

• Neg­li­gence

• Un­fair trade prac­tices

• Con­sumer pro­tec­tion con­tra­ven­tions

• Breach of fran­chise agree­ments

• Copy­right, patent or trade­mark in­fringe­ment

• Wrong­ful in­ter­fer­ence with a con­tract

• Ar­bi­tra­tion ser­vices in­curred in at­tempt­ing to re­solve a dis­pute that could po­ten­tially give rise to a claim.

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