VOLUME FIFTEEN
BENEFICIAL FINANCE - FUNDING, ASSET AND LIABILITY MANAGEMENT,
INTERNAL AUDIT, AND OTHER MATTERS CONSIDERED

 

 

CHAPTER 37
INTERNAL AUDIT OF BENEFICIAL FINANCE

 

 

TABLE OF CONTENTS

37.1 INTRODUCTION

37.2 SCOPE AND FORMAT OF THE CHAPTER

37.3 BACKGROUND AND REFERENCE INFORMATION
37.3.1 PURPOSE AND ROLE OF AN INTERNAL AUDIT FUNCTION
37.3.2 SHORT HISTORY OF THE BENEFICIAL FINANCE INTERNAL AUDIT DEPARTMENT

37.4 THE CHARTER OF THE INTERNAL AUDIT FUNCTION
37.4.1 INTERNAL AUDIT CHARTER
37.4.2 REPORTING LINES AND THE ISSUE OF INDEPENDENCE
37.4.3 ACCESS TO INFORMATION

37.5 APPROACH AND PROGRAMS
37.5.1 INTERNAL AUDIT DEPARTMENT COVERAGE
37.5.1.1 Introduction
37.5.1.2 Beneficial Finance's Restructuring
37.5.1.3 Internal Audit Department's Response to Beneficial Finance's Restructuring
37.5.1.4 Internal Audit Department's Focus on High Risk Areas
37.5.1.5 Introduction of Risk Asset Reviews
37.5.1.6 External Auditor's Reports on Internal Audit Coverage
37.5.1.7 Observations on Internal Audit Coverage
37.5.2 INTERNAL AUDIT DEPARTMENT APPROACH AND METHODOLOGY

37.6 RESOURCES AND EXPERTISE IN THE INTERNAL AUDIT DEPARTMENT

37.7 THE AUDIT COMMITTEE

37.8 SUPERVISION, DIRECTION AND CONTROL OF THE INTERNAL AUDIT FUNCTION
37.8.1 REPORTING TO THE BENEFICIAL FINANCE BOARD
37.8.2 THE USE OF GRADINGS
37.8.3 EXAMPLES OF REPORTS TO THE BENEFICIAL FINANCE BOARD
37.8.4 THE BENEFICIAL FINANCE BOARD'S RESPONSES TO AUDIT REPORTS
37.8.5 AN ANALYSIS OF THE BENEFICIAL FINANCE BOARD'S RESPONSE TO "SATISFACTORY MINUS" AND "UNSATISFACTORY" GRADINGS
37.8.6 OBSERVATIONS ON INTERNAL AUDIT REPORTING TO BOARD

37.9 CONCLUSIONS

37.10 REPORT IN ACCORDANCE WITH TERMS OF APPOINTMENT
37.10.1 TERM OF APPOINTMENT A
37.10.2 TERM OF APPOINTMENT C

 

 

 

37.1 INTRODUCTION

 

The focus of this Chapter of the Report is on the Internal Audit activity of Beneficial Finance Corporation Limited ("Beneficial Finance"). Beneficial Finance was a significant asset holding entity of the Bank Group with its total assets growing from $502.0M as at 1 July 1984 to $2,806.5M as at February 1991.() By February 1991, Beneficial Finance was reporting a total risk exposure to non-productive assets() of $965.3M, with a worst case risk/loss prognosis of $412.9M, against which specific provisions of $209.2M were being carried.()

Beneficial Finance held significant amounts of money invested by members of the public pursuant to its debenture and unsecured note issues. As such, the public was entitled to expect that proper standards of internal control would be operative at all times.

Beneficial Finance had an established Internal Audit function prior to it becoming a subsidiary of the Bank. This activity continued to function within Beneficial Finance, and operated independently of the Bank's internal audit function until 1990. In 1990, the Internal Audit department of Beneficial Finance was incorporated into the Bank's Group Internal Audit function.

Chapter 23 -"Internal Audit of the State Bank" of my first Report, which deals with the Internal Audit function of the Bank, sets out in detail my views as to the role and function of Internal Audit within organisations, and these observations are as relevant to Beneficial Finance as they are to the Bank.

Consistent with the roles and responsibilities ordinarily associated with Internal Audit functions within organisations, Beneficial Finance's Internal Audit department did not perform, and was not responsible for, the statutory financial statement audits. This responsibility rested with the company's external auditors.

The Internal Audit activity of Beneficial Finance is considered under Terms of Appointment A(b), A(c), A(d), A(e), A(g) and C. Term of Appointment A(g) specifically requires the Auditor-General to inquire into and report on:

"...(g) whether the internal audits of the accounts of ... Beneficial Finance Corporation Ltd ... were appropriate and adequate".

So far as Term of Appointment A(b) is concerned, the "operations" engaged in by Beneficial Finance were its lending activities generally. These activities were subject to review by Internal Audit and accordingly the appropriateness and adequacy of the discharge of the Internal Audit function is considered as affecting the appropriateness of the processes referred to in this Term of Appointment.

The effect of the abovementioned Terms of Appointment in relation to the Internal Audit function of the Bank is discussed in Section 23.1.1 of Chapter 23 of my first Report. For the purposes of this Chapter, that discussion in relation to these Terms of Appointment may be read as if a reference to the Bank were a reference to Beneficial Finance.

In this Chapter, a reference to the "Non-Executive Directors" is a reference to Mr L Barrett, Mr N Barrell, Mr T M Clark, Mr M G Hamilton, Mr R D Malcolmson, Mr K S Matthews, Mr A R Prowse, Mr C H Rennie, Mr R P Searcy, Mr D W Simmons, Mr J B Studdy, Mr A G Summers and Mr K D Williams. Details of the tenure in office of each of these directors are shown in Chapter 28 - "Overview of Beneficial Finance Corporation Limited". Any reference to the Non-Executive Directors in relation to a finding in this Chapter is reference only to those of the Non-Executive Directors who are the subject of findings made in the Chapter.

 

37.2 SCOPE AND FORMAT OF THE CHAPTER

 

This Chapter initially considers the purpose and role of an Internal Audit function and then sets out a short history of the Internal Audit department within Beneficial Finance.

An examination is made of the "charter" of the Internal Audit function in the context of the department's authorities, its reporting lines, its independence within the management structure, and its ability to access information necessary to conduct audits.

The Chapter then examines the department's audit approach and programs, including its coverage of Beneficial Finance's operations and the resources and expertise available within the department to perform Internal Audit functions.

Next, the Chapter looks briefly at the demise of the Audit Committee within Beneficial Finance and then considers the information made available to the Board by way of Internal Audit department quarterly reports. A comparison is made of those reports with the corresponding reports to the Board on substantive issues raised by Internal Audit.

Finally, the Chapter states my conclusions and findings concerning the Internal Audit function within Beneficial Finance.

 

37.3 BACKGROUND AND REFERENCE INFORMATION

 

37.3.1 PURPOSE AND ROLE OF AN INTERNAL AUDIT FUNCTION

As commented above in the Introduction to this Chapter, my views as to the purpose and role of an internal audit function within organisations are set out in detail in Chapter 23 of my first Report. So far as Beneficial Finance is concerned, its accounting and external audit functions were regulated under the Corporations Law and that Law's predecessor enactments. At no time during the reporting period was there any statutory requirement specifying the purpose and role of an internal audit function of a company subject to that legislation.

Beneficial Finance was a continuous borrowing corporation for the purposes of the Corporations Law and its predecessor enactments, and as such, was required to present six monthly independent (external) audited accounts, and other certified reports, to the trustee for debenture holders. In this regard, the necessary certifications required under the Debenture Trust Deed were the responsibility of Management and the external auditors. Internal Audit played an important part in assisting Management and the Board to discharge their respective obligations to keep the trustee for debenture holders informed of matters required to be reported in accordance with the Debenture Trust Deed. The Internal Audit department also played a role in assisting the external auditors discharge their obligation to provide an auditor's certificate on the required financial statements.

As noted elsewhere in this Report, the business activities of Beneficial Finance underwent a significant change during the period under review. At various stages over this period, these changes included the establishment of an Investment Banking division, a Treasury and Capital Markets division, a Structured Finance and Projects division, a Real Estate Services division, and an Asset Management division. The nature, complexity, and size, of some of the transactions that were entered into, when aggregated, were significant with respect to both on-balance sheet and off-balance sheet matters. These transactions gave rise to new and significant risk exposures for the company.

Accepted principles of financial management, as well as an efficient and effective discharge of the Board's and Management's responsibilities under the Debenture Trust Deed, called for an adequate internal audit resource base which had as its focus the high risk areas of the company's operations.

This Chapter examines the ability of the internal audit function to assist Management by reviewing and reporting on the procedures, policies and practices adopted by Beneficial Finance in the management of its resources and widespread assets.

37.3.2 SHORT HISTORY OF THE BENEFICIAL FINANCE INTERNAL AUDIT DEPARTMENT

Beneficial Finance's Internal Audit department was established prior to the company becoming a subsidiary of the Bank. From 1984 to 1988, the department was headed by a Manager, Mr S Spadavecchia, who reported to various divisional heads.

These divisional heads were:

(a) 1984: General Manager, Staff Operations - Mr T Siegele.

(b) 1985: General Manager, Finance and Administration - Mr J G Graham.

(c) 1986-87: General Manager, Professional Services - Mr B D Barton.

(d) 1988: Chief General Manager, Finance Credit and Personnel - Mr M Chakravarti.

These divisional heads had various responsibilities (but substantially in financial areas) and all reported to the Managing Director.

Mr Spadavecchia continued in his position as Manager of Internal Audit department until July 1988 when he was appointed Chief Manager, Credit Audit and Procedures, a position he occupied until September 1988.

In late 1988, Mr Spadavecchia moved to another area of the company's operations, and two regional audit managers, Mr M Wilson and Mr S Kassam assumed responsibility for particular areas within the department, and reported directly to Mr Chakravarti until Mr Siegele was made responsible for Internal Audit.

In July 1989, Mr Siegele was appointed Chief Manager of the Internal Audit department. At the same time, Mr Siegele was (and continued thereafter as) a member of the Head Office Credit Committee of Beneficial Finance.

Mr D Teroxy was appointed General Manager, Credit, Audit and Procedures, on 1 July 1989 and from that point on Mr Siegele reported to Mr Teroxy until May 1990, when Mr Siegele became Chief Manager, Credit Control.

As of May 1990, Mr A Kane occupied the position of Chief Manager, Internal Audit, and reported to Mr G J Yelland, General Manager, Professional Services division.

In November 1990, Beneficial Finance's Internal Audit department was incorporated into the Bank's Group Internal Audit of which Mrs M Chin was the Chief Manager.

 

37.4 THE CHARTER OF THE INTERNAL AUDIT FUNCTION

 

37.4.1 INTERNAL AUDIT CHARTER

An Internal Audit Charter formally proclaims to all parts of an organisation the role, responsibilities and authority of Internal Audit.

The Internal Audit department of Beneficial Finance operated from 1984 to November 1990 without an Audit Charter formally sanctioned by the Beneficial Finance Board.

There was no evidence that a formal Audit Charter had ever been considered or adopted by the Beneficial Finance Board, although a draft charter had been prepared by Mr Spadavecchia. This draft charter was not, however, ratified for adoption.

Whilst Beneficial Finance Internal Audit department operated without a formal Audit Charter, from 1984, the Department issued and maintained a comprehensive Internal Audit Manual which provided guidance on goals, objectives, independence, scope, programs, checklists, reporting, and various administrative matters.

In my opinion, the promulgation of an approved formal Internal Audit Charter in Beneficial Finance would have enhanced the status and general understanding of the authorities and the responsibilities of the Internal Audit department. There is, however, no evidence that the Internal Audit department's authorities and responsibilities were not in fact clearly understood in Beneficial Finance. Furthermore, there is no evidence that the discharge of the functions of the Internal Audit department was, in fact, hampered by the absence of an approved formal Internal Audit Charter.

37.4.2 REPORTING LINES AND THE ISSUE OF INDEPENDENCE

Beneficial Finance's own Internal Audit Manual set out clearly the reasons for independence and how this should be achieved:

"... It is essential that the [internal audit] function be independent of all activities to be audited. This allows work to be performed freely and objectively.

This independence is obtained primarily through organisational status and objectivity:

... The head of the internal auditing function therefore should be responsible to an officer whose authority is sufficient to assure both a broad range of audit coverage and the adequate consideration of and effective action on the audit findings and recommendations.

... An internal auditor should not develop and install procedures, prepare records, or engage in any other activity which he would normally review and appraise and which could reasonably be construed to compromise his independence." () (Emphasis Added).

During the period under review, the head of the Internal Audit department reported to various divisional heads, each of whom were potentially auditees with respect to other areas within their portfolio of responsibilities. In addition, the head of Internal Audit had a "dotted line" directly to the Managing Director and to the Chairman of the Board.() Internal Audit department's open line to the Chairman of the Board and the Managing Director was reaffirmed by the Board on 28 July 1989.() There was no formal arrangement that required the head of Internal Audit to attend Board meetings during the presentation of, and discussion on, the Department's Quarterly Reports to the Board. The Managing Director or the Executive Divisional Head (to which the head of Internal Audit reported) were responsible for responding to any issues that the Board members raised with regard to the Quarterly Reports. The head of Internal Audit had, however, no reason for "jumping" the senior management and going direct to the Managing Director and/or the Chairman of the Board, when, to all appearances, matters raised by Internal Audit were placed before the Board for its attention.

Whilst there is no evidence that the independence of the Internal Audit department was, in fact, compromised by virtue of direct reporting lines to divisional heads who were potentially auditees, the reporting structure was, in my opinion, nonetheless unsound having regard to the potential for the divisional head, as a potential auditee, to influence internal audit's scope, approach, methodology and reporting. Such influence may be exercised by direct interference or in an indirect way such as by restricting the budget available to the Department to perform its functions, or by refusing or delaying personnel recruitment which may be seen by the Department as essential for it to discharge its audit programmes.

In my opinion, the independence of the Internal Audit department was potentially most seriously compromised during the period that Mr Siegele was Chief Manager, Audit, and also a member of the Head Office Credit Committee. This arrangement was directly contrary to the company's own Internal Audit Manual which warned against an internal auditor engaging in any activity that he would normally review and appraise and that could reasonably be construed as compromising his independence.() Whilst I am of the opinion that this arrangement was structurally unsound, there is no evidence that this arrangement, in fact, interfered with or compromised the discharge by the Internal Audit department of its functions.

37.4.3 ACCESS TO INFORMATION

Beneficial Finance's Internal Audit Manual noted that the Internal Audit department had "a mandate to ensure all areas [of Beneficial Finance's operations] are reviewed".() The Manual, however, provided the following exclusion in relation to Internal Audit activity:

"... however, our external auditors audit the payrolls, secretarial and legal departments, and financial statement accounts."

Whilst there is no evidence that the Internal Audit department was denied access to areas in relation to which it had a "mandate", I am of the opinion that the limitation on the Internal Audit department's "mandate" in relation to the payrolls, secretarial, and legal departments, was wrong in principle. Internal Audit can make its most valuable contribution to an organisation when it has unrestricted authority to effect audit coverage over all important areas of the organisation. To limit access is to limit the effectiveness of the audit role.

The assertion that review of internal controls within payrolls, secretarial, and legal departments, was the responsibility of the external auditors was not, in my opinion, appropriate. This was particularly so having regard to the terms of the appointment of the external auditors and the qualification as to their involvement in reviewing internal control systems, a matter that was repeated on a number of occasions in their letters to management.

In a letter dated 1 December 1987 addressed to Mr Graham and copied to Mr J A Baker and Mr Spadavecchia, the external auditors, Price Waterhouse, stated the following:

"It must be appreciated that the matters dealt with in this document came to our notice during the conduct of our normal audit procedures which are designed primarily with the view to the expression of our opinion on the accounts of the company. Furthermore, our audit approach relies on an effective performance by the group's Internal Audit department. Consequently, Price Waterhouse only perform limited testing on Beneficial's accounting systems and internal controls. (Emphasis added)"

Whilst I regard the arrangements in relation to Internal Audit of payrolls, secretarial, and legal departments as structurally unsound, I make it clear that there is no evidence before the Investigation to suggest that these arrangements were not in fact properly administered by the external agency. The absence of such evidence is, however, fortuitous and cannot be accounted to Mr Baker as a mark of support on his part for Internal Audit.

 

37.5 APPROACH AND PROGRAMS

 

37.5.1 INTERNAL AUDIT DEPARTMENT COVERAGE

37.5.1.1 Introduction

The Internal Audit Manual defined the Internal Audit functional scope to encompass:

"All operations of the company where the following steps can be done:

1. Reviewing and appraising the soundness, adequacy, and application of accounting, financial and other operating costs, and promoting effective control at a reasonable cost.

2. Ascertaining the extent of compliance to established policies, procedures and plans.

3. Ascertaining the extent to which company assets are accounted for and safeguarded from losses of all kinds.

4. Ascertaining reliability of management data developed within [the] organisation.

5. Appraising the effectiveness of current methods employed in carrying out assigned responsibilities; this may lead to:

6. Recommending operating and systems improvements.

7. Non routine special investigations instigated by senior management.

Obviously some of these could be applied to every area, and thus internal audit has a mandate to ensure all areas are reviewed." ()

The first quarterly report to the Beneficial Finance Board, for the period to December 1984, summarised the departmental audit plan for the 1985 calendar year:

"Our emphasis during 1984 was on branch visits because of the deterioration of internal control in some branches - Sydney, Newcastle, Parramatta and Melbourne. The results of the latest round of audits has shown that problems identified are not recurring to the extent that the Quality Improvement Committee has now been disbanded.

We have therefore decided, in conjunction with the Managing Director, to increase the mix of head office work, particularly in the areas of EDP and new products."

This Report also noted that fourteen Internal Audit Reports had been issued during the reporting period covering the following areas: seven branches, one nationwide, two head office, one termination of employment, and two special assignments.

The Report also set out a table highlighting twenty six significant items reported on in the Internal Audit Reports, together with their distribution within the company. The matters covered were as follows:

(a) securities;

(b) real estate lending;

(c) lease lending/securities;

(d) administration/internal control;

(e) progress payments;

(f) collection;

(g) funds; and

(h) others.

More detail on the nature of the department's reporting to the Board is set out in Section 37.8 below.

A summary of the planned audit coverage was attached to the Quarterly Report for the period to December 1984. This summary indicated that 50 per cent of audit resources would be devoted to Head Office audits during 1985. Whilst it is conceded that an analysis of the number of reports generated in relation to particular auditable areas is not determinative of the level of resources devoted to audits of those areas, it is to be observed, that during the calendar year 1985, the Department reported to the Beneficial Finance Board that twelve head office audits had been conducted out of a total of forty two audits. These forty two audits covered areas designated as: head office, branches, "nationwide", terminations of employment, special assignments, new products, and joint ventures. In the calendar year 1986, the Department conducted ten head office audits out of a total of forty three audits and in calendar year 1987, nineteen head office audits out of a total of forty nine audits.

Over the period under review, categories of audit coverage as reported to the Board changed to reflect the company's, and the Internal Audit department's, restructuring.

The rapid and significant growth in assets, together with the company's diversification over the period under review, into complex, and high valued transactions, saw not only substantial corporate re-organisation, but also refocussing by the Internal Audit department on high risk areas of the company's operations.

37.5.1.2 Beneficial Finance's Restructuring

Up until June 1988, Beneficial Finance's lending activities were conducted within a Corporate Services division and a Retail and Commercial Services division.

In July 1988, the company underwent a major restructure which saw the establishment of an Investment Banking division. It was this Division that was becoming the main growth area of the company's operations. At the same time, a Treasury and Capital Markets division was also established.

In July 1989, the Investment Banking division was split into two departments, namely, Investment Banking division and Structured Finance and Projects division. Under this arrangement, Structured Finance and Projects division retained responsibility for structured facilities, client exposures in excess of $10.0M, overseas transactions, and certain selected customers. The Investment Banking division maintained control of corporate equity investments, investment banking, and non real estate joint ventures.

The company underwent a further restructure later in 1989 to establish the Real Estate Projects Services department in addition to the Structured Finance and Projects division and the Investment Banking division.

By 1990, the difficulties confronting the company forced a further major restructuring which saw the establishment of an Investment Banking division, an Asset Management division (to manage non-performing loans and to take over part of the operations of Structured Finance and Projects division) and an Australian Business division which picked up the remaining aspects of the Structured Finance and Projects division, together with the Northern division and Southern Business division operations.

Throughout this period, the company also maintained a number of support service departments.

37.5.1.3 Internal Audit Department's Response to Beneficial Finance's Restructuring

In accordance with the departmental audit plan for the 1985 calendar year, the Internal Audit department maintained an active focus upon Head Office functions in addition to audits of new products and joint ventures.

In July 1986, the Department held an Internal Audit Conference, which reviewed its existing work practices and priorities, with the aim of formulating future strategies to meet the challenges of Beneficial Finance as a dynamic and expanding organisation. This conference identified five major changes required to enable the Department to meet future demands. These were as follows:

(a) Increase activity in Head Office departments, particularly Treasury, Business Development and Corporate Investments.

(b) Implement a regular comprehensive review of lending.

(c) Improve the skill levels and experience of department staff.

(d) Improve the content and format of audit reports, including ratings.

(e) Utilise the specialist skills of key personnel in Head Office, State and Branch Operations, to undertake special audit assignments.

These major changes identified by the Internal Audit Conference were reported to the Board in the department's Quarterly Report for the period July to September 1986. This Report was accepted by the Board at its meeting on 21 October 1986; the Board Minutes record:

"The report showed some positive improvements during a period of change in systems and staffing."()

In the calendar year 1986, the Department maintained an active involvement in special assignments, branch audits and Head Office audits, but also expanded its activities into joint ventures and reviews of lending. In the calendar year 1987, the Department increased significantly its activity in the area of lending review, conducting a total of ten audits in this area out of a total of forty nine whilst continuing to maintain its activities in the branch, Head Office and special assignment areas.

In July 1988, the Internal Audit department divided into two sections, namely, northern and southern, the latter incorporating Head Office audits.

During the last quarter of 1988, after securing staff resources to deal with audits in the newly established Investment Banking division, the Department conducted two audits of this division. In addition, the Department maintained an active review of Beneficial Finance's joint venture involvement with five audits in the nine months to December 1988.

37.5.1.4 Internal Audit Department's Focus on High Risk Areas

In the last quarter of 1988, a project risk matrix was developed by the Department to assist it in identifying high risk areas in the Investment Banking division. This audit risk assessment was reported to the Board in the Internal Audit Quarterly Report for the period October to December 1988, which was presented to and reviewed by the Board on 27 January 1989.()

This matrix provided the following overall ratings for risk areas identified:

(a) structured deals - moderate to high;

(b) real estate projects - high;

(c) project share projects - high;

(d) guarantees - moderate;

(e) normal lending - low to moderate;

(f) equity investments - low to moderate; and

(g) affiliate companies - moderate.

On 29 April 1989, the Board was advised that Internal Audit department had presented no specific reports on the Investment Banking division during the quarter January to March 1989, but that considerable work had been done on developing "the general project roles checklist, individual project check lists for 10 of the 16 identified roles Beneficial Finance might take on a project, a process responsibility matrix and an Investment Banking project general ledger cross reference list".()

In the quarter April to June 1989, the Department conducted two specific audits of the Investment Banking division, three special audits, three joint venture audits, two field audits and two Head Office audits, the results of which were reported to the Board in the Quarterly Internal Audit Report for the period. Matters relating to Internal Audit department's reporting to the Beneficial Finance Board are noted below in Section 37.8.

37.5.1.5 Introduction of Risk Asset Reviews

In October 1989, the Department reported to the Board that the audit function had been segmented into two broad areas, Compliance Audit and Risk Asset Review.() During the period July to September 1989, the Internal Audit department also focussed attention upon the newly created Structured Finance and Projects division with six audits being conducted in this area. In the following three month period, the Department conducted a further three audits in the Structured Finance and Projects division and also four Risk Asset Reviews (as had been foreshadowed in the Board Report with the restructuring of the Internal Audit department). During 1989, the Department reported to the Board on a total of seventeen audits of Beneficial Finance joint ventures. Again, these audits were reported to the Board in the relevant Quarterly Internal Audit Reports.

During the period April to June 1990, the Internal Audit department came under the wing of the newly created Professional Services division. The Department's Quarterly Report to the Board for the period April to June 1990 noted that:

"The decision to expand the audit-based knowledge and concentrate on risk asset reviews has proved prudent in the current economic environment and has provided a valuable management tool to identify areas requiring additional management effort. As well, there is continued diligence to provide recommendations for improving internal control and strengthening existing procedures that will ensure maximum protection of BFCL assets." ()

The Quarterly Report also reported on the following departmental initiatives:

(a) review of all contingent liabilities to ensure completeness of exposure is known and corresponding security is accurately recorded;

(b) increased liaisons with external auditors both in the review of joint venture investments and by providing assistance with year end debtors circularisation and bank reconciliation; and

(c) review of past audit reports to ensure timely implementation of Audit's recommendations.()

The Quarterly Report was reviewed by the Board on 27 July 1990.()

During the period July to September 1990, the Internal Audit department continued to concentrate its efforts on Risk Asset Reviews.()

In November 1990, Beneficial Finance's Internal Audit department was integrated into the Bank's Group Internal Audit and a separate audit section to perform the audit assignments in Beneficial Finance was established within Group Internal Audit.()

37.5.1.6 External Auditor's Reports on Internal Audit Coverage

The Internal Audit department's audit coverage was also the subject of letters to management presented by the external auditors, Price Waterhouse. In a letter dated 1 December 1987, addressed to Mr Graham, the external auditors noted that the department's work programs, sample sizes, and rotational plans, adequately tested the company's core business in the branches and regions. The external auditors went on to record:

"In view of the recent changes in accounting systems and organisation, together with the growth of new products, we consider that Internal Audit should place more emphasis on head office systems.

We take comfort from the fact that Internal Audit is planned to spend a substantial amount of time testing head office systems during the six months ended 30 June 1987." ()

During the six months period ended 30 June 1987, the Department conducted nine Head Office audits out of a total of twenty five audits.()

The management letter addressed to Mr Graham for the half year ended 31 December 1987, included the following comments:

"The review of all Internal Audit reports reveal that coverage and quality of review is good and satisfy our requirements for forming an opinion of the controls within the system ...

Apart from branch audits, the department was involved in special reviews of various areas such as bank reconciliations, treasury functions and others. This serves to provide comfort on more than just the lending controls of the company and achieves the objective of our being able to rely on the department for the maintenance of control within the organisation."

The letter to management addressed to Mr Spadavecchia, dated 10 November 1988, in respect of the year ended 30 June 1988, noted that the Department had performed sufficient work to enable the external auditors "to form an opinion on the controls in the system". The external auditors also noted that the Department had undergone a very high turnover of staff with all but one member transferring out to other areas within Beneficial Finance. The external auditors added, however, that training was being given to the audit staff and a new approach to audit planning and priorities had been taken which would result in effective audits.

This letter to management also conveyed that:

"... a review of all Internal Audit reports reveal that coverage and quality of review is good and satisfy our requirement for forming an opinion of the controls within the system".

The external auditors' letter to management addressed to Mr Chakravarti, dated 28 April 1989, concerning the audit for the six months to 31 December 1988, also conveyed that the Internal Audit department had performed sufficient work to enable the external auditors "to form an opinion on the controls within the system".

37.5.1.7 Observations on Internal Audit Coverage

Having regard to all the available evidence, I am satisfied that the Internal Audit department's coverage of auditable areas within Beneficial Finance was adequate during the whole of the period under review.

37.5.2 INTERNAL AUDIT DEPARTMENT APPROACH AND METHODOLOGY

Annual Internal Audit plans were prepared by the Department and the 1985 Plan was presented to the Beneficial Finance Board for review. There is no evidence that subsequent plans were presented to the Board. In 1988, risk ratings/weightings were applied to individual areas as noted above,() and from this, the Department's work was prioritised to cover the high exposures first. As a consequence of this, less emphasis was placed on branch audits and more emphasis placed on joint ventures and risk asset reviews.

This change in emphasis also necessitated a revision of audit approach to effectively audit these activities.

Section 110 of the Internal Audit department Manual outlined "seven steps of internal audit" as follows:

"1. Risk assessment and setting of specific audit objectives for each area.

2. Selection of audit sample from the population. Our computer system selects specific and random samples based on given criteria.

3. Manual sub-selection to meet audit sample objectives.

4. Branch visits using audit programs and check lists.

5. Branch employee compliance/non-compliance to the audit check list.

6. Managerial responses to all audit inquiries while still at the branch.

7. Report on scope of work, significant items, non-significant items and overall rating."()

A review by the Investigation of a sample of files indicated that programs were used to ensure a thorough completion of tasks. When a matter was identified, a single sheet audit memorandum was completed with full documentation of the finding. This memorandum was given to the auditee for a response and then all memoranda were collated for reporting in the final audit report.

In February 1989, the Internal Audit department produced specific internal control and audit check lists for the Investment Banking division and, in July 1989, developed specific internal control and audit requirements for the Structured Finance and Projects division. As commented previously, the Investment Banking division was established in July 1988 and was split into a Structured Finance and Projects division and an Investment Banking division in July 1989.

 

37.6 RESOURCES AND EXPERTISE IN THE INTERNAL AUDIT DEPARTMENT

 

Beginning with a staff of three in 1984, the Internal Audit department expanded to eight in 1988, including specialist EDP auditors. Throughout this period, the Department was managed by Mr Spadavecchia, who was a qualified chartered accountant with audit and EDP experience.

Support staff either had accounting qualifications, finance company experience, or audit experience. At various stages throughout the period under review, other employees with specific finance company experience were seconded to the Department and the Department engaged in secondment or interchange arrangements with both the Bank's Internal Audit department and with its external auditors.

Geographical coverage was achieved, from November 1986 until November 1990, by maintaining an Internal Audit office in Sydney to cover the eastern States of Australia.

At its meeting on 31 January 1985, the Beneficial Finance Board:

"... recommended that there should be a continuing review of the audit plans for the 1985 calendar year to ensure [Beneficial Finance has] sufficient staff available to ensure appropriate standards are maintained". ()

From this point on, the Board kept the issue of resources and expertise in the Department under review and Management was active in reporting to the Board on matters relating to the resources and expertise within the Department, as the following examples illustrate:

(a) The Board Minutes of the meeting held on 19 February 1985 record that the Managing Director reported that Beneficial Finance was then in the market for an additional staff member for Internal Audit and that the staffing requirements of the Department would be kept under review to ensure the effective completion of the Internal Audit program for 1985.

(b) At its meeting on 30 July 1985, the Board "questioned whether the company had sufficient people in the Internal Audit section to ensure that it can fulfil its role with maximum effect".()

(c) At its meeting on 17 September 1985, the Beneficial Finance Board discussed the problems being experienced in finding the right staff for the Internal Audit department. The minutes of this meeting record that "we should seek older ex-finance company staff or part-time assistance as possible solutions".()

(d) The Internal Audit Department's Quarterly Report for the period July to September 1988 recorded that, during that quarter, four experienced auditing personnel had been appointed to the Internal Audit department. This Report was considered by the Beneficial Finance Board on 28 October 1988 and the minutes of this meeting record the following:

"Over recent months, the changes in organisation structure had affected the Internal Audit division, but recent restructuring within the division and of new appointments had significantly improved the depth and experience of the team."

At their meeting held on 28 April 1989,() the Beneficial Finance Board noted that additional Internal Audit staff would be appointed to improve the area of coverage of the Internal Audit program.

Apart from the above specific references to staffing issues in the Board Minutes, the Beneficial Finance Board received a steady flow of information about the staffing issues eg recruitment, termination, secondments, etc, in the Internal Audit department Quarterly Reports.

In a letter dated 17 January 1991, addressed to the Managing Director of Beneficial Finance, the external auditors noted that the ability of the Department to carry out its functions was under pressure during the period reviewed in the Letter to Management (ie financial year ended 30 June 1990):

"... Due to recent reorganisations, the overall resources of the Internal Audit department have decreased significantly. As a result the ability of Internal Audit to maintain the current volume and the standard of work may be hindered, especially given the likely need for quality risk asset reviews in the current economic climate."

This report indicated that action had been taken by the company to address these problems. In particular, it was noted that commencing from November 1990 the company's internal audit functions were performed by the Bank's Group Internal Audit in conjunction with and with reference to the external auditors.

I am satisfied that throughout the period under review the Beneficial Finance Board was alert to staffing issues affecting the Department's capacity to perform its functions and that Management regularly reported to the Board on staffing issues in this regard.

Having regard to all the available evidence, I am satisfied that, throughout the period under review, Beneficial Finance Internal Audit department maintained an adequate level of staff resource, skill and experience, and that it acted in securing replacement or additional resources as circumstances required.

 

37.7 THE AUDIT COMMITTEE

 

As commented in Chapter 23 of my first Report, an audit committee is a sub-committee of an organisation's Board, with the primary role of assisting the Board in the discharge of its responsibilities for ethical financial reporting and for maintaining a system of internal control. The objectives of an audit committee vary for each organisation, but, generally include the following:

(a) to improve the quality of financial reporting;

(b) to ensure that the organisation's Board makes informed decisions regarding accounting policies, practices, and disclosures; and

(c) to review the scope and outcome of internal and external audits.

Beneficial Finance established an audit committee in the late 1970's and the Chairman, Mr Studdy was:

"... rather proud Beneficial had one a long time before any other public companies did." ()

The Audit Committee had operated for some time before Beneficial Finance became a subsidiary of the State Bank and in the words of Mr Studdy it was:

"... a fairly active audit committee. We met regularly four or five times a year. We met with the internal auditors and with the external auditors. We got from the internal auditors directly major matters arising from their audit reports so they came straight to us and they did not go through Management." ()

In Mr Studdy's view, the benefit was that there was:

"A lot of useful work and a lot more open discussion by having a small Audit Committee where Management were there but they weren't part of the Committee, and where I think both external and internal auditors spoke with a lot more freedom and informality than they did when they sat around a large Board table." ()

Following the acquisition of Beneficial Finance by the Bank, the Audit Committee comprised Mr Studdy, Mr Williams, Mr Clark and Mr Barrett. The Audit Committee met only once on 31 July 1984 and the minutes of that meeting were received at the Beneficial Finance Board meeting on 5 September 1984.

The Beneficial Finance Board Minutes of 1 August 1984 contained the following decision in relation to Board Sub-Committees then in place:

"Audit Committee: a committee comprising Messrs Studdy, Williams, Clark and Barrett with Mr T Siegele as Secretary, will only meet as required. In future the internal auditor will submit a quarterly report, showing trends and special matters of interest, direct to the Board commencing with the quarter ending 30 September 1984. A decision on the future of the Audit Committee will be made early in 1985 after completion of the current half year's operations."

The Audit Committee never met again. Internal Audit matters relating to Beneficial Finance were eventually taken up by the Bank's Audit Committee when it was established on 28 June 1990.()

In evidence to the Investigation, Mr Studdy said:

"... It was made quite clear by Mr Marcus Clark that he didn't like committees or the State Bank didn't like them." ()

The only apparent explanation provided by Mr Clark to Mr Studdy was:

"That the State Bank didn't believe in committees or Board committees, that it believed the whole Board should participate in discussions or in any committee work." ()

In his submission to the Investigation, Mr Clark stated that he had "no recollection of making any such statement to Mr Studdy nor does he believe that it is likely that he did". Mr Clark, in his submission, further pointed to attendance by the head of Internal Audit at Board Meetings and the consistent flow of information to the Board in relation to the activities of the Internal Audit department. I am satisfied that Mr Clark's views as to the whole Board acting as an Audit Committee were consistent with those he held in relation to the Bank Board which I deal with in Chapter 23 of my first Report.

In my opinion, and as I have indicated in Chapter 23 in relation to the Bank's Audit Committee, an Audit Committee provides a far more focussed and dedicated environment for dealing with Internal Audit matters. The combination of Board Directors' membership, and regular reporting by Internal Audit to the Audit Committee, provides the opportunity to pursue and evaluate in detail, matters relating to the organisation's operations, including systems and controls, in a way that would not be possible at a normal Board meeting. The disbanding of the Audit Committee weakened the accountability relationship between management and the Board and deprived the Board itself of gaining regular and indepth independent feedback concerning the strengths and weaknesses of the Company's operations.

In my opinion, the Beneficial Finance Board, knowing that the Audit Committee (which operated up until August 1984) enhanced its awareness of the Company's operations, allowed itself to be persuaded by the reasoning of Mr Clark to disband the Committee. In so doing, the Board dispensed with an accountability arrangement important to the role of adequately and properly supervising, directing, and controlling, the affairs of Beneficial Finance.

 

37.8 SUPERVISION, DIRECTION AND CONTROL OF THE INTERNAL AUDIT FUNCTION

 

The Investigation paid particular regard to the Internal Audit department's reports to Board and Management and to the Board's response to reports of audit findings. This aspect of the review was relevant to the issue of supervision, direction and control of the internal audit function.

A consideration of the adequacy and effectiveness of an internal audit function properly includes consideration of the Board's responses to reported audit findings. The status and independence of the Internal Audit department is obviously and seriously compromised if the Board adopts a simple "hands off" approach to adverse internal audit findings. This leaves the Internal Audit department without the clear support of the Board to resolve outstanding issues with auditee management concerned.

The rest of this section of the Chapter focuses attention on the matter of reporting and the Board's responses to the Department's reports.

37.8.1 REPORTING TO THE BENEFICIAL FINANCE BOARD

Each quarter, the Audit Reports generated during that period were summarised into the Internal Audit department's Quarterly Report for submission to the Beneficial Finance Board.

During the period under review, the Internal Audit department conducted some 300 audits and, with very few exceptions, Audit Reports were issued to auditees in relation to these audits.

A comparison of specific Audit Reports with their corresponding summaries in the Quarterly Report to the Beneficial Finance Board highlighted the difficulties in conveying the extent of Internal Audit concerns in the brief precis permitted.

In the period 1987 to 1988, Internal Audit Quarterly Reports to the Board approximated seven to eight pages, but in 1989 to 1990, these reports were condensed down to two to four pages.

Notwithstanding these difficulties, and that, in some cases, not every concern raised in the Internal Audit Report was conveyed in the summary, the Investigation is satisfied that there was a sufficient level of reporting which, together with the grading system() applied to particular summaries of audit findings after the Quarterly Internal Audit Report for the period April to June 1987, was sufficient to put the Board on notice as to the essential concerns raised by Internal Audit in the substantive reports.

During the period 1987 to 1988, there were no Internal Audit Reports with rankings below "Satisfactory". In the period January to December 1989, the Quarterly Internal Audit Reports indicated seven Internal Audit Reports with a "Satisfactory Minus" rating and two reports with an "Unsatisfactory" rating. In the nine months from January to September 1990, the Beneficial Finance Quarterly Reports recorded four "Unsatisfactory" audit findings and eight "Satisfactory Minus" audit findings.

In the period October to December 1990, the Beneficial Finance reports were included within Group Internal Audit's report and, in this three month period, three "Unsatisfactory" audit findings were recorded.

Under the grading system applicable up until September 1990 "Unsatisfactory" and "Satisfactory Minus" findings (and in the period October to December 1990, "Unsatisfactory" gradings under the Group Internal Audit criteria) indicated a potential loss to Beneficial Finance or a significant breakdown in internal control procedures or defalcation.

37.8.2 THE USE OF GRADINGS

From the time of Beneficial Finance's becoming a subsidiary of the Bank, the Internal Audit department applied a grading system to audit findings in accordance with the following categories:

(a) Excellent (E);

(b) Satisfactory plus (S+);

(c) Satisfactory (S);

(d) Satisfactory minus (S-); and

(e) Unsatisfactory (U).()

These gradings were recorded as a result of a numerically based rating system which took into account:

(a) adherence to company policy and procedures;

(b) resolution of items raised in previous audits;

(c) record keeping;

(d) customer services; and

(e) office presentation.

Relative weights were assigned to each of the above areas with adherence to company policy and procedures attracting the greatest relative weight of 5:1.

The grading system applied by Beneficial Finance Internal Audit department did not correlate precisely with the grading system introduced by the Bank's Internal Audit department in January 1990.

Under the Beneficial Finance Internal Audit grading system, to qualify for "Satisfactory Plus", there had to be complete adherence to policy and procedures (equivalent to the Bank's definition for excellent); internal controls for a "Satisfactory" rating had to be good rather than adequate; and Beneficial Finance's "Satisfactory Minus" rating covered an audit which identified a loss or potential risk of loss for the company.

For an "Unsatisfactory" rating to be given to an audited area within Beneficial Finance, there had to be either:

(a) a material loss (actual or potential);

(b) a significant breakdown in internal control procedures; or

(c) defalcation.

From December 1984, Quarterly Reports to the Beneficial Finance Board indicated audit gradings in a comparative form, and from July 1987 gradings for specific audits were noted next to the heading of the audit report summary.

Specific reports on audits conducted also indicated a grading, and in a number of cases a comparative grading having regard to previous audits of the same area or account. The substantive Internal Audit Reports were issued not only to the auditee but also to the departmental head responsible for the auditee, the Managing Director, and the external auditors, Price Waterhouse.

From the date of issue of the Report, the auditee had one month to respond to the Managing Director and Group Audit. There were occasions when the auditee failed to meet the deadline for response to tentative audit findings. During the period that he was Managing Director, Mr Baker pursued these responses and maintained an audit correspondence file that included responses to audit findings.

37.8.3 EXAMPLES OF REPORTS TO THE BENEFICIAL FINANCE BOARD

The following are examples of the Internal Audit department's reporting in the Quarterly Report to the Beneficial Finance Board:

(a) Report January to March 1989, named account (grading Satisfactory Minus):

"Problems were noted across the broad range of the joint venture's operations. In the lending area these included approvals not being in line with policy and approval conditions not being fully complied with or alterations not subsequently ratified. The appointment of an Administration Manager was strongly recommended to support the current management structure and implement the controls necessary to alleviate the reported deficiencies." ()

(b) Report July to September 1989, named joint venture (grading Unsatisfactory):

"This venture has grown from doing around 350 transactions a month early last year to the current level of 900-1000 a month. We believe that the growth in business has not been properly controlled, primarily as a result of inexperienced Performers [ie staff]. In some instances the correct approval authority was not observed and some approval conditions were waived. The settlement procedure does not include signing off conditions and securities were not kept in a fire proof safe. Some transactions were incorrectly documented. The Collections function requires greater control." ()

(c) Report July to September 1989, named account (grading Satisfactory Minus to Unsatisfactory):

"In a number of files, consideration of the first way out (repayment of loan from normal trading) was not demonstrated or macro issues relative to the client's industry/market/competition. Little evidence existed of verification or analysis of information submitted by brokers and short term loans generally lacked assessment of ability to refinance elsewhere. It was recommended that further formalised lending policies be developed as an urgent priority." ()

(d) Report October to December 1989, Pegasus (grading Satisfactory Minus):

"The audit indicated some significant problems and highlighted issues raised in the previous Audit Report which still had not been addressed. Deficiencies in the lending area related mainly to correct approvals not being obtained for transactions totalling $12.5 million ... The debt factoring business generally lacked management and internal controls in both the account maintenance and administration areas. The insurance broking division non-payment of accrued taxes and duty totalled some $130K. There was a lack of account reconciliations between general and subsidiary ledgers and inefficiencies and increased potential for error in utilising two different computer systems to record and process information." ()

(e) Report October to December 1989, named joint venture (grading Satisfactory Minus):

"Several matters require to be addressed at [joint venture] Board level to ensure that the internal controls and practices ... are consistent and/or acceptable to [Beneficial Finance] viz the interpretation of exposure levels (gross or net) ... lending procedures in relation to sale and leaseback transactions. There were also accounting issues which resulted in us not being able to satisfy ourselves as to the integrity of the monthly account reporting. Our audit also indicated that continued losses on residuals over and above the budget calls for a reassessment of the loss provision (planned for February Board meeting). The collections activity and arrears reporting also require improvement. Steps are already in motion for the resolution of these various matters."()

(f) Report January to March 1990, named joint venture (grading Unsatisfactory):

"The previous audit indicated there were a number of areas that required prompt attention. The current audit findings demonstrate that whilst some of the matters were satisfactorily implemented, a number require improvement via introduction of procedures and internal controls. The settlement process had deficiencies and Beneficial requirements in relation to insurance were not observed. Authorised approval limits were exceeded. Approval conditions were not complied with, and Beneficial credit procedures were not observed for transactions involving sale and leaseback, livestock, bloodstock, rural and aircraft. Clear evidence of serviceability was not demonstrated on a number of loans, and there is no panel of valuers, solicitors or an accredited list of brokers approved by the [joint venture] Board." ()

(g) Report April to June 1990, named account (account management grading Satisfactory Minus; project risk grading Satisfactory Minus):

"The report highlighted a number of instances where account management was inadequate. The overriding deficiency was that no Board ratification was obtained for an increase in [Beneficial Finance] lending exposure of $1.2M. From a loss risk position, the review highlighted the scope for losses, which could not be quantified at the time of the review because of the following:-

(i) The failure of the original operator and absence of a replacement;

(ii) Questions regarding the builder's solvency." ()

(h) Report April to June 1990, named joint venture (project risk grading Satisfactory Minus):

"... we were concerned that the valuation accepted on this proposal contained disclaimers because of reliance upon information supplied by an interested party and, in our opinion, had several anomalies in determining the "as is" valuation." ()

(i) Report July to September 1990, named account (grading Unsatisfactory):

"The review indicates numerous issues which require attention. Detailed responses to our questions had not been received, at the time of the field work, and we had therefore been unable to satisfy ourselves that the normal controls required on such arrangements are fully in place. We understand that responses have now been furnished to the Managing Director and action is being taken." ()

(j) Report July to September 1990, named account (grading Satisfactory Minus):

"The report highlighted a number of instances where account management was less than adequate [including] no Board ratification of some loan variations. From a risk position concerns were raised in relation to the enforceability of the unconditional contract of sale and the ability of the purchaser to finance the property should the contract be enforceable."()

(k) Report July to September 1990, named account (grading Satisfactory Minus):

"As a result of the potential to incur a loss, anomalies in the approval process, and the deficiencies in financial analysis, the overall rating was S-." ()

37.8.4 THE BENEFICIAL FINANCE BOARD'S RESPONSES TO AUDIT REPORTS

An analysis by the Investigation of the Beneficial Finance Board minutes, indicates that the Board was prepared to give directions to Management in a general sense in relation to audit findings as reported in the Quarterly Reports. The following matters are extracted from the Beneficial Finance Board Minutes:

(a) Board Meeting, 21 May 1985

"Report No 2 for the three months to March 1985 was reviewed by the Board and it was considered that a number of the problems covered in the Report reflected the symptoms of rapid growth over the past year. Concern was expressed about instances of non-compliance with approval conditions and it was considered that in cases where second instances are reported, serious action be taken to ensure the stricter maintenance of standards." ()

(b) Meeting, 17 September 1985

The Board considered and commented upon a fraud effected through the Sydney branch, a review of Brisbane accounts, and delays experienced in solicitors lodging securities for registration.

(c) Board Meeting, 30 January 1986

"Concern was expressed at the continuing S- for Sydney branch. It was considered that general ratings were not high enough on other branches and that there is a need for more branch audits. With regard to significant item E the Board considered that where approval conditions are not being implemented or rules obeyed, Management should consider dismissal of the person/s involved." ()

(d) Board Meeting, 29 April 1986

"Concern was expressed at the problems still being reported in connection with Sydney administration and operating weaknesses. Urgent action is to be undertaken to overcome the problems. A progress update is to be given to the next Board meeting." ()

(e) Board Meeting, 29 July 1986

"Concern was expressed at the adverse reports relating to Newcastle branch and the Board received a verbal report from the Managing Director on action taken." ()

(f) Board Meeting, 21 October 1986

"The Board reiterated the importance of approval conditions being met at all times and expressed concern at the finding relating to the foreign currency transaction."()

(g) Board Meeting, 24 April 1987

"Concern was shown at the number of unauthorised alterations to approval. The importance of compliance with the lending limits needs to be stressed to employees noting that any breaches to limits will be dealt with severely. Internal Audit was requested to allocate more time to head office procedures and concentrate on major risk areas with less emphasis on "green ink" ticking." ()

(h) Board Meeting, 29 July 1988

"In relation to the loss mentioned in the SA/NT region commercial services division section of the Report, the Board is to be advised of the size of the amount involved." ()

(i) Board Meeting, 28 October 1988

"3 areas of vulnerability had been identified and will receive attention:

- Investment Banking division - building a greater understanding of the complex transactions;

- joint ventures - difficulties with other parties involved in the ventures;

- WA situation - need for a strengthening of internal controls."()

(j) Board Meeting, 27 January 1989

The Board reviewed the project risk matrix presented by Internal Audit department.()

(k) Board Meeting, 28 April 1989

"Following the problems encountered across a range of activities in the [named] Joint Venture, Management considers that in any future joint ventures, Beneficial administration people should be appointed to ensure that the proper systems and procedures are installed and followed." ()

(l) Board Meeting, 27 April 1990

"... [The Internal Audit] review was accepted. It was noted that future Treasury and EDP systems audit would be conducted by the State Bank. Management [was] requested to introduce procedures to prevent any variations between the terms of the submission approvals in terms of final settlement with the client." ()

(k) Board Meeting, 27 July 1990

"Less than satisfactory ratings were reported on one Procedural Audit and three Risk Asset Reviews. The Board emphasised that procedures must be adhered to. If procedures are outdated then they should be formally changed rather than breached." ()

There is, however, no reference in the minutes to any specific directions being given by the Beneficial Finance Board in response to findings of particular audit reports other than those indicated in the above extracts.

37.8.5 AN ANALYSIS OF THE BENEFICIAL FINANCE BOARD'S RESPONSE TO "SATISFACTORY MINUS" AND "UNSATISFACTORY" GRADINGS

In the period September 1989 to September 1990, there were three Internal Audit Reports each quarter which carried a rating of "Satisfactory Minus" or "Unsatisfactory" but the maximum number of "lines" devoted to these particular reports was eleven. Individual Internal Audit Reports with fourteen to eighteen pages were summarised in four to six lines in the Quarterly Reports, and, in one instance, a forty four page report was summarised in five lines in the Quarterly Report. I am not critical of the need to condense these reports. What is at issue is the awareness that was brought to the Board's notice of the importance of matters dealt with in the discharge of the internal audit function.

A comparison of the Board Minutes to the specific "Satisfactory Minus" and "Unsatisfactory" gradings noted in the Quarterly Reports is as follows:

(a) Quarterly Report January to March 1989 - one "Satisfactory Minus" finding - this matter is noted in the Board Minutes of 28 April 1989.()

(b) Quarterly Report July to September 1989 - two "Unsatisfactory" findings(), three "Satisfactory Minus" findings - no specific comment in relation to any of these matters is recorded in Board Minutes of 27 October 1989.

(c) Quarterly Report October to December 1989 - two "Satisfactory Minus" findings - no specific comment recorded in Board Minutes of 26 January 1990.()

(d) Quarterly Report January to March 1990 - three "Unsatisfactory" findings - one of these matters is the subject of comment recorded in Board Minutes of 27 April 1990.()

(e) Quarterly Report April to June 1990 - five "Satisfactory Minus" findings - these matters are noted in the Board Minutes of 27 July 1990.()

(f) Quarterly Report July to September 1990 - three "Satisfactory Minus" and one "Unsatisfactory" finding - no specific comment recorded in the Board Minutes of 26 October 1990.()

37.8.6 OBSERVATIONS ON INTERNAL AUDIT REPORTING TO BOARD

There is no doubt that the substantive Internal Audit Reports underwent a heavy editing process in order to present concise summaries in the Quarterly Report to the Board. Having regard to all of the evidence, I am of the opinion, that the reports to the Beneficial Finance Board by the Internal Audit department were sufficient to put the Board on notice as to the essential issues raised in the substantive Internal Audit Reports.

It was, therefore, open to the Board collectively or to directors individually, if they were so minded, to seek to obtain copies of the substantive reports or to call for detailed explanations or expanded reports from management, particularly from the head of Internal Audit, as to matters of concern referred to in the substantive audit reports.

Apart from the Board Minutes of 28 April 1989 and 27 July 1990, the Board Minutes relating to the Quarterly Reports contain no specific reference or comment on those audits reported as "Satisfactory Minus" or "Unsatisfactory". Furthermore, no Board Minute records commentary indicating inquiry or probing by the Board, of management of the reasons for the gradings and the potential loss exposure of Beneficial Finance.

It cannot be concluded from the absence of such commentary in the Board Minutes that there was no inquiry or probing of management by the Board in relation to adverse Internal Audit findings and gradings.

The Non-Executive Directors submitted to me that they did these things. Their submission of 30 April 1993 states:

"... It is quite impossible to use the Board Minutes to gauge the "level of attention" given by the Board to any particular matter, given that there may have been significant non-minuted discussion ..."

"In any event, the tabling of quarterly internal audit reports at the Beneficial Board Meeting gave rise to keen discussion. Directors raised many matters with the Managing Director and the internal auditor and it is not true to say that there was no probing of audit findings and gradings."

The submission of 17 December 1992 from Mr Clark comments:

"... that there was a regular attendance by Mr Spadavecchia between 1984 and 1988 on behalf of the Internal Audit Department of Beneficial Finance at regular Board Meetings."

In common with the submission from the Non-Executive Directors, Mr Clark's submission does not extend to provide an insight into the role associated with the attendance by the heads of Internal Audit at the meetings ie an indication of the discussion agenda (specific or general), length of meeting, and nature of the communication process (passive or active).

Mr J A Baker's submission of 15 December 1992 conveys that:

"... the Internal Audit Manager did attend Board meetings on occasions."

Again, the submission provides no further commentary that elucidates the nature of the role associated with the attendance by the heads of Internal Audit at meetings and the mode of conduct of such meetings. The submission, however, points to attendance `on occasions' by the heads of Internal Audit, while the submission of Mr Clark indicated `regular' attendance during the period 1984 to 1988.

Enquiries were made of the heads of Internal Audit, Mr Spadavecchia, Mr Siegele and Mr Kane, to clarify the frequency and nature of their respective attendance at Board meetings, particularly meetings at which the Quarterly Reports were tabled.

A written submission received from the Bank on behalf of the respective heads of Internal Audit in relation to this matter, indicates, that there was no Board or Executive Management arrangement that provided for the heads of Internal Audit to attend the Board meetings at which the Quarterly Reports were tabled. The submission advised the following:

"Mr Spadavecchia attended one Board meeting on 29 July 1988 due to the absence of Mr Chakravarti who was overseas. Mr Siegele did not attend a Board meeting at which the Quarterly review was discussed.

Mr Kane did not attend any meetings of the Board and received no request from any member of the Board to attend any meeting or provide explanation or further detail on any matter reported in the Quarterly Board Report.

Mr Kane was requested by Mr Simmons and Mr Hamilton to conduct special reviews. These were completed and the detailed reports duly issued to them."

The submission from the Bank on behalf of heads of Internal Audit further conveyed that:

"The Managing Director was a recipient of all detailed Audit Papers and considered that it was his duty to respond to any of the issues that the Board Members may raise with regard to the Report.

In addition in 1987 and 1988 both Mr Riechert and Mr Chakravarti attended Board meetings regularly to assist the Managing Director."

On the basis of the evidence available to me I am satisfied, that enquiries by Board members in relation to the Quarterly Audit Reports were directed principally to the Managing Director as a regular attendee at meetings rather than the heads of Internal Audit.

I am of the opinion, that the Board did not accord sufficient priority and importance to the review and analysis of Internal Audit findings and gradings. Summary Reports of complex findings contained in various substantive Internal Audit Reports were presented to the full Board on a quarterly basis, at which heads of Internal Audit were not in attendance and principal responsibility for responding to matters raised in connection with the Reports rested with the Managing Director. This situation provided a very limited forum for dealing with matters relating to Internal Audit.

The constraints imposed by reporting in summary form and the complex findings contained in the substantive Internal Audit Reports, required of the Board a far more inquiring approach than was in fact adopted by it, especially in relation to those reports carrying "Satisfactory Minus" and "Unsatisfactory" gradings. The Board relied on Management's attention and representations relating to the matters summarised in the Quarterly Reports, and this without appropriate independent inquiry of outcomes from the Heads of Internal Audit. In my opinion, in so doing the Board failed to adequately or properly supervise, direct, and control, the affairs of Beneficial Finance.

Further, in my opinion, the disbandment of the Audit Committee by the Beneficial Finance Board, deprived the Board itself of a specific forum which would have facilitated indepth analysis of Internal Audit Reports' findings, and gradings, and related accountability matters. As previously commented in Section 37.7 - "Audit Committee", the Board dispensed with an accountability arrangement important to its role of adequately and properly supervising, directing, and controlling, the affairs of Beneficial Finance.

 

37.9 CONCLUSIONS

 

In the examination of the internal audit function within Beneficial Finance, the Investigation had regard to the following matters:

(a) Internal Audit charter;

(b) reporting lines and the issue of independence;

(c) access to information;

(d) coverage of risk areas of operation;

(e) approach and methodology;

(f) resources and expertise in the Internal Audit department; and

(g) Audit Committee.

In addition, particular attention has been focussed on the reporting lines to the Beneficial Finance Board, the nature of the reports to the Board, and the Board's responses to the findings reported in the Quarterly Reports.

With respect to the matters referred to above, my general conclusions are as stated hereunder:

(a) Internal Audit Charter

In my opinion, whilst the promulgation of an approved formal Internal Audit Charter would have enhanced the status and general understanding of the authorities and responsibilities of the Internal Audit department within Beneficial Finance, I am satisfied that the absence of such a charter did not interfere with, or compromise, the discharge by the Internal Audit department of its functions.

(b) Reporting Lines and the Issue of Independence

The requirement for the Internal Audit department to report to a divisional executive who was potentially a significant auditee, in my opinion, was a structural deficiency in the organisational arrangements within Beneficial Finance. There is, however, no evidence that this structural deficiency in fact interfered with, or compromised, the discharge by the Internal Audit department of its functions.

(c) Access to Information

In my opinion, the exclusion from the Internal Audit department's "mandate" in relation to the audit of payroll, secretarial, and legal departments, was wrong in principle but, subject to this exception, I am of the opinion that, throughout the period under review by the Investigation, the Internal Audit department had sufficient access to information to enable it to discharge its functions within the areas in respect of which it had a mandate.

(d) Coverage of Risk Areas of Operation

I am satisfied that throughout the period under review, the Internal Audit department's coverage of risk areas of the company's operations was adequate.

(e) Department Approach and Methodology

I am satisfied that the department's approach and methodology throughout the period under review was, in all the circumstances, appropriate.

(f) Resources and Expertise in the Internal Audit Department

I am satisfied that throughout the period under review, Beneficial Finance maintained an adequate level of staff resource, skill, and experience and that adequate attention was given to securing replacement or additional resources as circumstances required.

(g) Audit Committee

The disbanding of the Audit Committee of Beneficial Finance represents a significant strategic error on the part of the Board, and hence in this matter it acted inappropriately. The abolition of the Committee deprived the Board of a forum which would have facilitated greater indepth analysis of significant matters arising from Internal Audit reviews and greater discussion on related accountability issues. The disbandment of the Audit Committee placed the Board in a position whereby, through its own act, it was handicapped in its ability to manage the company. In this matter the Board failed to adequately or properly supervise, direct and control the affairs of Beneficial Finance.

(h) Internal Audit Department Reports to Board and Management

In my opinion, it was appropriate for the management of Beneficial Finance to present summaries of the often lengthy substantive Internal Audit reports to the Beneficial Finance Board in the Internal Audit department's Quarterly Reports. Nonetheless, it was imperative that at all times, the essential nature of the substantive reports was so conveyed and the Board alerted to issues of concern.

Whilst a number of the summaries presented in the Quarterly Report demonstrate the pressures of this process, I am satisfied that, on the available evidence, the essential nature of the Internal Audit department's substantive reports were conveyed to the Board and were sufficient to put the Board on notice as to the essential issues raised in the substantive Internal Audit reports. This process was facilitated with the use of the grading system which put the Board specifically on notice in relation to matters reported as carrying a grading of "Unsatisfactory" or "Satisfactory Minus".

The Board's response to certain "Unsatisfactory" and "Satisfactory Minus" gradings by the Internal Audit department was inadequate and in these matters the Board failed to adequately or properly supervise, direct, and control the affairs of the Company.

In my opinion, a far greater level of attention was, in all the circumstances, called for from the Beneficial Finance Board to respond to reports which clearly put the Board on notice that significant breakdowns in internal control systems had been identified and that the assets of the company were at risk. In these matters the Board had a responsibility to establish timetables and other mechanisms to ensure that adequate internal control systems were re-established in relation to the problems identified in the Internal Audit Reports.

I am of the opinion that the Board did not give sufficient priority and importance to the review and analysis of Internal Audit Reports. Meetings of the full Board at which Quarterly Audit Reports were tabled, together with the non attendance by the heads of Internal Audit at these meetings, provided a very limited forum for dealing with matters relating to Internal Audit. As indicated above, the Audit Committee was an effective and proper forum for the review and analysis of Internal Audit findings and gradings. Its disbandment weakened the supervision, direction and control process exercised by the Board over the affairs of Beneficial Finance.

 

37.10 REPORT IN ACCORDANCE WITH TERMS OF APPOINTMENT

 

37.10.1 TERM OF APPOINTMENT A

In the introduction of this Chapter I referred to the fact that Internal Audit is considered under Term of Appointment A(b), A(c), A(d) and A(e). This is because, in my opinion, the function was an integral part of the management processes within Beneficial Finance.

In addition, and more particularly, Internal Audit is considered in the context of Term of Appointment A(g) which specifically requires inquiry into and reporting on the appropriateness and adequacy of the Internal Audits of the accounts of Beneficial Finance.

I hereby report that, in my opinion, whilst the execution of the internal audit function per se can, in general, be said to have been adequate, the procedures adopted by the Board in response to important matters raised by internal audit reports, was, in some important respects, inadequate.

37.10.2 TERM OF APPOINTMENT C

I have also, as directed by my Term of Appointment C, investigated and inquired into matters relating to the supervision, direction and control of Beneficial Finance with reference to the internal audit function. Having regard to all the available evidence and for the reasons indicated in this Chapter, I hereby report that, in my opinion, the Beneficial Finance Board, in disbanding the Audit Committee, dispensed with an important accountability arrangement, and in so doing, the Board failed to adequately or properly, supervise, direct, and control, the operations, affairs and transactions of Beneficial Finance.

Further, the Board in failing to take effective action in the knowledge of "Unsatisfactory" and "Satisfactory Minus" gradings by Internal Audit did not exercise the level of directorial attention that was called for in the circumstances, and thereby failed to adequately or properly supervise, direct and control the affairs of the Company.