By: David Tate, Esq., Royse Law Firm, Northern and Southern California (Silicon Valley/Menlo Park Office) http://rroyselaw.com/
I have pasted below four links in which the authors discuss enterprise risk management (ERM) and risk management, the new COSO ERM framework, and some aspects of internal audit.
I appreciate what the authors are discussing; however, my preference would have been to have more defined tasks or requirements in the new COSO ERM framework (I use the word “requirements” broadly because generally there is no mandated risk management framework that must be followed, although for some industries and businesses there are some risk management requirements that are mandated by law and which must be followed).
It is clear that whatever risk management framework or process a business uses will remain largely discretionary based on the business judgment of management and the board, and that in fact might be better for possible liability purposes; however, it is my belief that people and businesses usually will implement policies or processes or procedures (other than, for example, for how to design, develop and manufacturer a product or service that they provide) if they are required to follow or adopt certain specific requirements by law, statute, regulation, or rule, or perhaps as required by the expectations of the community or stakeholders. That having been said, we are where we are on this. And it is now also generally accepted (and in some instances mandated) that a business will adopt and implement risk management, the board will oversee risk management, sometimes audit committees and/or risk committees are required to be involved in or oversee risk management, and in some businesses the board will delegate risk management oversight to a committee of the board, to the extent that risk oversight can be delegated (I would maintain that the board still must oversee risk management with the help of the committee and that the board cannot delegate its overall responsibility to oversee risk management).
In my view, the components and principles outlined in the new COSO ERM framework are essentially only broad in nature, which allows for each business to decide how to design and implement, etc., enterprise risk management based on the business judgment of management and the board of that particular business, in light of the business’ mission, core values, business objectives, strategies, and views and evaluations of related risks.
Let me also say this, I do appreciate that the first of the five core components in the new COSO ERM framework is Governance and Culture, and that the fifth of the five components is Information, Communication, and Reporting which also includes principle 19 (Communicates Risk Information) and principle 20 (Reports on Risk, Culture, and Performance). I believe that including governance, culture, communication and reporting (if they are adopted – remember, no specific framework is mandated) will help to move ERM and risk management to a more visible position. And, it is my belief, based on recent business, nonprofit, and governmental entity shortcomings and failures, that governance, culture, communication and reporting need to be moved more front and center. In fact, COSO listed governance and culture as the first of the five core components because governance and culture can be central to the entirety of the entity’s ERM.
The following are the links to the four enterprise risk management, etc., discussions that I mentioned at the beginning of this post, and below those links I have copied and pasted from my September 7, 2017, post in which I discussed the new COSO ERM framework and which you can also read at http://wp.me/p75iWX-aQ
The following are the links to the four additional discussions:
https://wordpress.com/read/feeds/254243/posts/1619082863
https://iaonline.theiia.org/2017/Pages/COSO-ERM-Getting-Risk-Management-Right.aspx
https://normanmarks.wordpress.com/2017/09/29/should-you-adopt-the-updated-coso-erm-framework-my-assessment/
https://www.protiviti.com/US-en/insights/bulletin-vol6-issue8?utm_medium=social&utm_source=ProSocial
COSO ERM Framework – Enterprise Risk Management – Integrating with Strategy and Performance (five components, and twenty principles)
I. Governance and Culture Component:
Supporting Principles:
- Exercises Board Risk Oversight
- Establishes Operating Structures
- Defines Desired Culture
- Demonstrates Commitment to Core Values
- Attracts, Develops, and Retains Capable Individuals
II. Strategy and Objective-Setting Component:
- Analyzes Business Context
- Defines Risk Appetite
- Evaluates Alternative Strategies
- Formulates Business Objectives
III. Performance Component:
- Identifies Risk
- Assesses Severity of Risk
- Prioritizes Risks
- Implements Risk Responses
- Develops Portfolio View
IV. Review and Revision Component:
- Assesses Substantial Change
- Reviews Risk and Performance
- Pursues Improvement in Enterprise Risk Management
V. Information, Communication, and Reporting Component:
- Leverages Information and Technology
- Communicates Risk Information
- Reports on Risk, Culture, and Performance
Enterprise Risk Management (ERM) and internal controls work together and should complement each other. The following is the broad outline of the COSO 2013 Internal Control Framework.
Sarbanes-Oxley section 404 requires public company management and its external auditors to attest to the design and operating effectiveness of a company’s internal control over external financial reporting. Internal controls should also be designed and implemented for private company, nonprofit and governmental entities.
COSO 2013 Internal Control Framework – 5 Components, and 17 Principles
1. Control Environment Component:
Mandatory Principles
- Demonstrate commitment to integrity and ethical values.
- Board of directors demonstrates independence from management and exercises oversight of the development and performance of internal control.
- Management establishes, with board oversight, structures and reporting lines and appropriate authorities and responsibilities in the pursuit of objectives.
- Demonstrate commitment to attract, develop and retain competent individuals in alignment with objectives.
- Hold individuals accountable for their internal control responsibilities in the pursuit of objectives.
2. Risk Assessment Component:
Mandatory Principles
- Specify objectives with sufficient clarity to enable the identification and assessment of risks relating to objectives.
- Identify risks to the achievement of its objectives across the entity and analyze risks as a basis for determining how the risks should be managed.
- Consider the potential for fraud in assessing risks to the achievement of objectives.
- Identify and assess changes that could significantly impact the system of internal control.
3. Control Activities Component:
Mandatory Principles
- Select and develop control activities that contribute to the mitigation of risks to the achievement of objectives and acceptable levels.
- Select and develop general control activities over technology to support the achievement of objectives.
- Deploy control activities through policies that establish what is expected and procedures that put policies into action.
4. Information & Communication Component:
Mandatory Principles
- Obtain or generate and use relevant, quality information to support the functioning of internal control.
- Internally communicate information, including objectives and responsibilities for internal control, necessary to support the functioning of internal control.
- Communicate with external parties regarding matters affecting the functioning of internal control.
5. Monitoring Activities Component:
Mandatory Principles
- Select, develop and perform ongoing and/or separate evaluations to ascertain whether the components of internal control are present and functioning.
- Evaluate and communicate internal control deficiencies in a timely manner to those parties responsible for taking corrective action, including senior management and the board of directors, as appropriate.
The Business Judgment Rule
The business judgment rule also is relevant on these topics (from Tate’s Excellent Audit Committee Guide). The business judgment rule provides a director with a defense to personal liability, holding that as a general principle of law, a director, including a director who serves as a member of a board committee, who satisfies the business judgment rule has satisfied his or her duties. Thus, the business judgment rule provides one standard of care, although other standards may very well also apply to specific tasks and responsibilities. The business judgment rule provides a very good overall approach for directors and audit committee members to follow, although the rule itself is lacking in specific detail. In some states the business judgment rule is codified by statute while in other states the rule is established by case law (see, i.e., Cal. Corp. Code §309 for California corporations, Del. Gen. Corp. Law §141 for Delaware corporations, in addition to relevant case law). The rule also applies to directors as board committee members.
The Business Judgment Rule
In summary, as a general principle the business judgment rule provides that a director should undertake his or her duties:
-In good faith, with honesty and without self-dealing, conflict or improper personal benefit;
-In a manner that the director reasonably believes to be in the best interests of the corporation and its shareholders; and
-With the care, including reasonable inquiry, that an ordinarily prudent person in a like position with like expertise would use under similar circumstances. The rule itself doesn’t require a particular level of expertise, knowledge or understanding; however, as you might be aware, public company audit committee members do have such a requirement, and you can at least argue that, depending on the facts and circumstances, a board or committee member should have or should obtain a certain unspecified level of knowledge or understanding to be sufficiently prepared to ask questions, evaluate information provided, and make decisions.
Reliance Upon Other People Under the Business Judgment Rule
In the course and scope of performing his or her duties, a director must necessarily obtain information from and rely upon other people. An independent director is not involved in the day-to-day operations of the business. The director provides an oversight function. Pursuant to the business judgment rule, a director is entitled to rely on information, opinions, reports or statements, including financial statements and other financial data, prepared or presented by any of the following:
-Officers or employees of the corporation whom the director reasonably believes to be reliable and competent in the relevant matters;
-Legal counsel, independent accountants or other persons as to matters that the director reasonably believes are within the person’s professional or expert competence; or
-A committee of the board on which the director does not serve, as to matters within that committee’s designated authority, so long as the director acts in good faith, after reasonable inquiry as warranted by the circumstances, and without knowledge that would cause reliance to be unwarranted.
David Tate, Esq., Royse Law Firm, California (Silicon Valley/Menlo Park office), with additional offices in San Francisco, Los Angeles and Orange County, http://rroyselaw.com/
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A blog discussing the law, D&O, governance, liability and other aspects of public and private businesses, not for profit organizations, and governmental entities – see additional detail below - note: sometimes I post information just to pass it along on these topics (not an endorsement), and sometimes I provide only brief comments or no comments, not a more full discussion. 