United States: Are The Insights Of Internal Auditors About Risk Getting Through To Boards?

Last Updated: May 21 2019
Article by Cydney Posner

Internal auditors are worried that boards are not paying enough attention to—wait for it—internal auditors. Probably most often, we consider the internal audit function in the context of financial reporting, but its brief can extend to many other risk areas. To be sure, the speed of technological development and disruption has accelerated the development of risks—exhibit one being the development of the internet, which has led to risks related to cyberattacks and privacy. A 2019 report regarding a survey by the Institute of Internal Auditors of over 500 chief audit executives (CAEs) concluded that these developments "place an even higher value and urgency on assuring that boards have complete and accurate information on which to base their decisions.... In today's dynamic risk environment, CAEs must do more than simply understand and fall in line behind the board's view on risk. This new outlook must center on assuring the board has a comprehensive and unencumbered understanding of the organization's risk universe." Nevertheless, according to the President and CEO of the IIA, CAEs responding to the survey said that "internal audit rarely reviews information provided to the board, with 6 in 10 [CAEs] reporting they provide such assurance only for unusual situations, or never." As a result, there were "serious questions about whether internal audit's insights and recommendations are getting through to boards."

As reported in the WSJ, the major concern is that boards are relying too much on information they receive from management: in the survey, ¾ of CAEs responded that "directors are 'very likely' to rely on management. Just under half said directors are just as likely to rely on internal auditors or corporate risk executives. That directors rely on CEOs and other senior leaders isn't surprising. What worries auditors, however, is that directors, particularly on the audit committee, may be placing too much weight in assurances they receive from management, rather than corroborating information with internal auditors to make sure companies have necessary controls in place." What may be missing, according to the IIA president, is "professional skepticism." To illustrate, he pointed to the "MeToo" movement, which caught a number of companies "off guard. If more companies had consulted their internal auditors about the adequacy of their reporting procedures, he told the WSJ, they may have been able to avoid the surprise: "[b]oards are looking around and saying, 'How did we miss that?'"

The survey and report identified four key risk areas that required more focus and management:

  1. Cybersecurity and Data Protection: Reputational harm related to data privacy breaches was a very high concern for 70% of CAEs. The survey found that focus on cyber and IT issues have increased and now represent nearly 20% of the average audit plan. Nevertheless, "individually these key issues continue to lag behind others considered lower risks by boards, such as operational, financial reporting, and compliance/regulatory," especially among public companies. With regard to risk assessment, the report advises that companies should use internal audit to "perform basic cybersecurity auditing with support from IT that does not require cyber expertise, such as identifying the organization's most significant assets in need of protection, testing insider threat controls and evaluating processes and structures designed to protect against accidental or inadvertent disclosure of organization information." CAEs also reported that they needed to improve the IT and cyber skills of their own staffs (including by considering outsourcing where necessary) and that efforts needed to be made to adjust audit plan allocations and resources and to take steps "to close any existing effort gaps in this key risk area." For example, while 80% of CAEs reported that they thought they should communicate to executive management and the board about the level of risk to the organization and efforts to address cybersecurity risks, only 53% actually did so. GDPR in Europe and state law privacy laws also need to be taken into account. The report advocates discussion with the audit committee about resource, time or skills deficits.
  2. Third-party Risks: According to survey respondents, 80% of organizations have third-party contracts for IT services and 70% have them for other business services, such as supply chain or accounting, all zones of potential fraud, corruption and operational and reputational risks. The survey reflected CAE concern about how third parties were selected and monitored, as well as "how ill-prepared organizations are for managing poorly performing vendors." Almost half of CAEs viewed monitoring by the organization of third-party relationships as "ad hoc, weak, or non-existent"; 21% applied that description to the selection process. And only 42% of CAEs said that their organizations had in place "recovery plans" (plans "designed to protect organizations by identifying a process for terminating contracts that minimizes disruption of services, limits legal liabilities, and protects the organizational assets and reputation") for "all third-party agreements or those that present higher risks to the organization." In fact, 53% of CAEs reported that recovery plans were created for certain third-party relationships, but the choices were not based on risk. The report suggested that companies needed further education about the integral role of third-party relationships with regard to the "organization's ecosystem of risk." Third-party relationships should not be viewed as separate, but rather "require the same level of risk management as any that affect the organization directly." And, the report suggests, CAEs and audit committees should engage regarding any CAE "concerns about weak controls on third-party risks."
  3. Emerging and Atypical Risks: According to the report, "dynamic geopolitical environments, shifting global economic conditions, and disruptive technology have brought emerging and atypical risks to the forefront of boardroom and C-suite discussions....Like never before, alignment and collaboration among all risk functions is vital as organizations identify, decipher, and assess emerging and atypical risks." Yet, in the survey, CAEs indicated that boards were "much more likely to turn to management than internal audit to identify and assess emerging or atypical risks." Although 80% of CAEs indicated "confidence in their organization's ability to identify and assess emerging or atypical risks," almost half responded that it is "fairly common that an emerging or atypical risk will surprise management in the course of a year," suggesting perhaps that those confidence levels may be a bit dicey. The report suggested that internal audit should play a larger role in identifying, assessing and monitoring these risks, including by monitoring "key risk indicators (KRIs) that include precursors to emerging risk," which are more objective measures that can be presented to the board, and by using advanced data analytics. Only 30% of CAEs reported a high or moderate use of "advanced data analytics to identify and assess changes in risks that otherwise would not be apparent."
  4. Board and Management Activity: A number of recent cybersecurity and governance issues have intensified scrutiny of board oversight, not to mention the occasional appearance before Congress. According to the report, boards have begun to examine information from management even more diligently, and, in a recent NACD survey, 53% of board respondents complained that the quality of management information must improve. On the positive side, the CAE survey showed that 49% strongly agreed that management provides "all pertinent information" to the board, "not just that supportive of the views of management," and only 15% somewhat or strongly disagreed. (Note, however, that CAEs were not quite as sanguine when it came to the consideration by management of long-term effects). Still, 85% of CAE survey respondents agreed that "internal audit rarely or never provides assurance on management information sent to the board," and 57% reported they rarely or never discussed with the board or management "the accuracy, completeness, timeliness, truthfulness, and transparency of information going to the board." In addition, variations in committee structures and responsibilities may mean that some committees assigned to handle critical issues, such as cybersecurity and overall risk governance, may not normally interact with internal audit, impeding the ability of internal audit to convey its findings and insights to the board in these key risk areas. In addition, the line of reporting for internal audit may run more frequently to the CFO, potentially leading to excessive concentration on financial reporting risks—to the detriment of other risks, such as reputational risk or data privacy risk—and possibly making it more difficult for internal audit to convey information to the CEO. The report advocates that CAEs "push to attend/participate in other key board committees, such as IT, risk, or compensation committees, to ensure internal audit's views are clearly communicated to the board." Boards may want to take into consideration that "internal audit can provide assurance or advisory services on information the board receives," such as "negative assurance on [the] accuracy, completeness, timeliness, transparency, and reliability" of board materials.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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