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Could Internal Audits Have Prevented the LIBOR Scandal?

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One headline in particular blew me away this morning – “Banks Urged by Regulators to Adopt Tougher Internal Auditors.”  Well, duh.  While I am reasonably certain that the Chartered Institute for Internal Auditors expects its members to adhere to the highest possible standard of ethic and conduct, the way that the news is being reported. wherever I look, it almost sounds like internal auditors could have prevented the LIBOR rigging scandal from developing, at least at several of the banks that had been involved.  On the one hand that may been possible.  On the other hand, I believe that it is unlikely.

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On the One Hand

I’m not sure exactly what the average investor understands an internal audit to be.  I wasn’t sure either until I was trained as an auditor and was a Lead Internal Auditor for several years.  Ideally, the objective of internal auditing is to “Evaluate and improve the effectiveness of governance, risk management and control processes.”  Internal audit reports are delivered to senior executives and board members.

The BOE’s Andrew Bailey said that “Regulators expect banks to have internal auditors that can provide a challenge to management, to help protect the assets, reputation and sustainability of the organization.”

If auditors are adequately trained, if they are allowed complete freedom to  investigate without impedance, if they act and report with real authority, if the executives actually read the reports and recommended corrective actions, if the executives take the internal auditing process seriously, and if the executives themselves had high ethical standards, then the internal audit system usually delivers on its improvement objective.  But, as we all know, “If ‘ifs’ and ‘buts’ were candy and nuts, we’d all have a merry Christmas.”

On the Other Hand

Anyone who has had internal auditing experience should be able to tell you that providing “a challenge to management” isn’t their biggest obstacle, it is getting management to pay attention to the challenge and respond effectively and ethically to it.  The problem is generally not the auditors, it is what they are permitted access to and getting management  to act on the audit findings.

Management usually openly advocates internal auditing.  They have to do that to keep up appearances.  However, they can – and do – just as easily ignore taking action on the audit findings.  I am personally aware of occasions – not in UK banks – where top management rejected audit findings out of hand because the findings were contrary to one or more executives personal objectives.  In these cases the top execs attempt to present the uniformed investors with a form of internal auditing, but they deny the power of the process.

On the Third Hand

What?  Three hands?  What has three hands?  Clocks.  (Which always makes me wonder why the third hand is called the second hand.)

I am a relentless supporter of internal auditing.  In order to be effective, however, the auditors must not live in fear of losing their jobs if they uncover wrongdoing or operational shortcomings due to failure to follow defined procedures and ethical standards.  You would be a fool to think that internal auditors do not operate under this shadow.  Internal auditing is an ideal function that facilitates third-party external audits.  It like external auditing is the final exam and internal audits are the periodic tests along the way — Pass the regular tests and the final should be a snap.

Could Internal Audits Have Prevented the LIBOR Scandal?

Probably not.  The LIBOR scandal did not happen within the realm of normal daily operations as defined in a policy or procedure manual.  It was perpetuated by emails and phone calls.  These are not things that internal teams audit.  Don’t blame the auditors.  Even at their very best, their effectiveness is dependent upon top management.  When top management is involved in corruption, you can be fairly certain that their illegal activity will be hidden well beyond internal auditing’s ability to discover it.

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