As reported in Leasing News, Sterling Financial is struggling to survive in the aftermath of a major internal fraud committed at one of its financial services affiliates, Equipment Finance, LLC (EFI). Sterling currently expects to record a cumulative after-tax charge to its 2006 financial statements of approximately $145 million to $165 million, based upon the results of the investigation’s preliminary findings. Again, in the grand tradition of Enron, Tyco, and Worldcom, shareholders are going to take the hit. Which begs the question – “Where was SOX?”
Depending on with whom you speak, the Sarbanes-Oxley Act is either a costly, knee-jerk reaction to corporate excesses or a boon to shareholders in the form of protection from predatory executives. Although many people at the time thought that SOX, particularly Section 404, was essential to restoring confidence in the US capital markets, there have been many who subsequently have expressed reservations about its effectiveness. Even Michael Oxley, for whom SOX is named, recently stated that the act, if not wrong itself, was poorly implemented.
Irrespective of where you stand on the issue of SOX efficacy, the bottom line (how’s that for sweet accounting talk?) is that SOX was not an issue in the Sterling Financial debacle. Section 404 requires companies and their auditors to examine and report on the processes behind their financial reporting, with an emphasis on evaluating the internal controls associated with those processes.
Based on what I have read of the case, there were established processes and internal controls in place at EFI. Furthermore, they were tested by the independent auditors, who, I assume, adequately met their responsibilities. For those of you not familiar with internal controls, the internal control system relies on techniques such as segregation of duties, verification rules, reconciliations, and various levels of authorizations to prevent, detect, and identify errors and malfeasance. Unfortunately, virtually any internal control can be circumvented if a fraud is perpetrated through extensive collusion. This is what happened at EFI. The internal control system apparently was suborned at all levels.
No, this was not a looting of the corporation, or a padding of the financials. It was a flat out conspiracy to defraud the company. My guess is that EFI was not as much a SOX failure, as it was a case of a concerted, multi-level attempt to circumvent the internal controls put in place as a result of the SOX. You can even make the case that SOX was operating effectively, since the fraud was discovered internally through accounting department reconciliations and review.
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