1. Enron Briefing Clarkson Centre for Business Ethics CC(BE) 2 & Board Effectiveness—CC(BE) 2 & Executive Programs Rotman School of Management March 19, 2002

2. Rotman School of Management, March 19, 20022 Agenda  Background Enron Accounting Disclosure Manipulation  Enron Problems Structures, activities and disclosures Control and culture  Lessons Governance Accounting standards and profession Director’s Behaviour  Questions

3. Rotman School of Management, March 19, 20023 Rotman Briefing Team  Ramy Elitzur – Accounting, Audit Former Director, MBA Program, elitzur@rotman.utoronto.caelitzur@rotman.utoronto.ca  Irene Wiecek – Accounting, Audit Associate Director, MMPA, wiecek@rotman.utoronto.cawiecek@rotman.utoronto.ca  Eric Kirzner – Finance, Governance Director, Market Regulation Services, + kirzner@rotman.utoronto.cakirzner@rotman.utoronto.ca  Len Brooks – Governance, Ethics, Accounting, Audit Exec. Dir., The Clarkson Centre for Business Ethics & Board Effectiveness Director, Master of Management & Professional Accounting (MMPA) Director, Diploma in Investigative & Forensic Accounting (DIFA) brooks@rotman.utoronto.ca

4. Rotman School of Management, March 19, 20024 The Enron Affair  Management was: out of control, and engaged in self-dealing manipulating transactions & financial reports  Company imploded - Chap. 11 in Dec. 2001  Investors misled, pensions lost  Executives plead the 5th, poor memory, ignorance, incompetence  Outrage  Auditor savaged, profession to be changed

5. Rotman School of Management, March 19, 20025 Overview of Key Problems  Governance failure at the Board level Too much trust Incompetence - awareness and/or understanding of role, control & reporting systems Lack of motivation, conflicts of interest  Dishonest management, conflicts of interest  Culture of deception, self-interest  Manipulation of accounting and disclosure  Poor standard setting  Auditor deficiencies  Regulatory short-sightedness

6. Rotman School of Management, March 19, 20026 Enron Stock Chart Source: www.globe investor.com Weekly Prices 1997- 2002

7. Rotman School of Management, March 19, 20027 Enron’s Business (10K-2000)  Transportation and distribution  Wholesale services Commodity sales & services, risk management products, plants, etc  Retail energy services - gas, electricity  Broadband services Nationwide fiber-optic network - build, market, etc.  Corporate and other operation of water, renewable energy, and clean fuels plants plus other corporate activities

8. Rotman School of Management, March 19, 20028 Enron’s Income (IBIT): Income Before Interest, Minority Interest and Income Taxes 2000 1999 1998 Transport & distribution ($ mil.) Trans. Services 391 380 351 Portland General 341 305 286 Wholesale Services 2,260 1,317 968 Retail Energy Services 165 (68) (119) Broadband Services (60) Exploration & prod. - 65 128 Corporate and other (615) (4) (32) IBIT 2,482 1,995 1,582

9. Rotman School of Management, March 19, 20029 Enron’s Wholesale Services  …creation of networks involving selective asset ownership, contractual access to third-party assets and market-making activities. 10K p.36.  …uses portfolio and risk management disciplines, including offsetting or hedging transactions, to manage exposures to market price movements (commodities, interest rates, foreign currencies and equities). 10K p.37.  … sells interests in certain investments and other assets to improve liquidity and overall return, 10K p.37

10. Rotman School of Management, March 19, 200210 Enron’s Financial Data 200019991998 Revenues(in Billions)100.8 40.1 31.3 Operating income (Millions) 1,953 802 1,378 IBIT2,482 1,995 1,582 Net Income before Cumulative Accounting Changes 979 1,024 703 Net Income 979 893 703 EPS (in dollars) - basic 1.22 1.17 1.07 - diluted 1.12 1.10 1.01

11. Rotman School of Management, March 19, 200211 Enron’s Financial Data 20001999 Current assets(Billions)30.4 7.3 Investments, other23.4 15.4 Property, plant, equip, net11.7 10.7 Total Assets 65.533.4 Current liabilities28.4 6.8 Long-term Debt 8.6 7.2 Deferred credits and other13.8 6.5 Shareholders’ Equity11.5 9.6 Total Liab. & Shareholders’ Equity65.533.4

12. Rotman School of Management, March 19, 200212 Enron’s Changing Risk Profile Early By Risk 1990’s 2000 Level Pipelines, distribution networks Low Retail energy Low Power generation Low Oil and gas exploration Med. Alternative energy M/H Hedging transactions High Commodity trading transactions High Broadband optical fiber networks V. High Related party transact. (SPEs/Partnerships) ???

13. Rotman School of Management, March 19, 200213 Corporate Governance Role of the Board of Directors - traditional  strategic objectives - set or approve  company policies and procedures: set or approve ensure dissemination and compliance  laws, regulations, & expectations of society ensure monitoring and compliance act as ethical conscience (Dey Report & CICA)

14. Rotman School of Management, March 19, 200214 Enron’s Governance Failure Begins  1997 - Board suspends code of conduct to deal with an SPE (JEDI/Chewco) emergency (alternative controls considered …not implemented) Can’t find outside investor before year-end Non-consolidation tests not satisfied: Outside investor - 3%investment at risk, control.  Fastow (CFO) has Koppers - who reports to Fastow - appointed to run/invest/control SPE  Realization that guard is down/can be controlled

15. Rotman School of Management, March 19, 200215 Enron’s Governance Structure Board Ken Lay: Chair; Co-chair ZZZ Audit, Compensation Cees. Management Lay, Skilling: CEO Fastow, CFO; Koppers Causey, CAO; Buy, CRO Watkins; Kaminsky; McMahon Company Policies Code of Conduct Internal Audit ? Whistleblowers ? Auditor Arthur Andersen Outside Law Firm Consultant: Arthur Andersen Missing Suspended Compliance Guidance Finan. Reports SPEs © L. Brooks

16. Rotman School of Management, March 19, 200216 Governance Failure Allows  Fastow to control SPE transactions: Sales of assets at inflated prices (False gains) False hedging of losses on Enron investments (Falsely keeps losses off Enron Income Stat.) Exorbitant payments to Fastow & helpers Hiding of SPE debt ultimately to be borne by Enron  Fastow to create more SPEs (LJMs…)  Manipulation of accounting disclosure

17. Rotman School of Management, March 19, 200217 Partial Impact Payments to Fastow & helpers Invest._ Return Other Fastow $25,000 $4.5 mil in 2 mo. $30 mil+stock options+ Koppers 125,000 10 mil (incl. $2 mil in fees friend) 2 others 5,8001 mil Manipulated transactions in Q3 & Q4, 1999 Asset sales, plus 1 hedge $229 profit of $570 before tax and 549 after tax (~50%)

18. Rotman School of Management, March 19, 200218 Manipulation of Accounting Disclosure A Backgrounder The Accounting Art of War By Ramy Elitzur

19. Rotman School of Management, March 19, 200219 The Accounting Art of War “A Strategy of Positioning evades Reality and confronts through Illusion.” The Art of War by Sun Tzu © R.Elitzur

20. Rotman School of Management, March 19, 200220 The Accounting Art of War “Appearance and intention are fundamental to the Art of War. Appearance and intention mean the strategic use of ploys, the use of falsehoods to gain what is real.” The Book of Family Traditions on The Art of War, Yagyu Munenori © R.Elitzur

21. Rotman School of Management, March 19, 200221 The Accounting Art of War  The accounting art of war incorporates the entire menu of reporting strategies that management employs to manipulate financial statements.  Involves much more than earnings management. © R.Elitzur

22. Rotman School of Management, March 19, 200222 The Agency Framework  Modern corporations have a separation of ownership and management.  As such, there is an inherent conflict of interests between shareholders and managers.  Mechanisms to alleviate the agency problem: Compensation plan (to create goal congruence between shareholders and managers) Monitoring or auditing, both internal and external. © R.Elitzur

23. Rotman School of Management, March 19, 200223 The Agency Framework In The Context of Enron  The Mechanisms to alleviate the agency problem failed in Enron: The compensation plan: Not only it did not reduce the agency problem but it actually exacerbated it. Monitoring or auditing, both internal and external failed to bring the accounting problems to light. © R.Elitzur

24. Rotman School of Management, March 19, 200224 Tools in The Accounting Art of War  Earnings Management  Revenue Manipulation  Off-Balance-Sheet Liabilities  Sheer Opportunism © R.Elitzur

25. Rotman School of Management, March 19, 200225 Tools in The Accounting Art of War Earnings Management Companies may want to:  Increase reported earnings.  Decrease reported earnings.  Smooth earnings. © R.Elitzur

26. Rotman School of Management, March 19, 200226 Earnings Management  Merchant (1990) and Merchant and Bruns (1990) find that earnings management is a widespread phenomenon.  Furthermore, the same studies surveyed managers and report that, according to these managers, earnings management is an acceptable practice.

27. Rotman School of Management, March 19, 200227 Increasing Reported Earnings  Why?  This could increase bonus and other compensation. © R.Elitzur

28. Rotman School of Management, March 19, 200228 Examples  Enron  Waste Management where the company overstated income from 1992 to 1996 by more than US$ 1 billion.  Livent, Inc. © R.Elitzur

29. Rotman School of Management, March 19, 200229 Income Decreasing Strategy  Why?  In cases of monopoly because of anti- trust considerations.  Regulated utilities.  ‘Blood Bath’. © R.Elitzur

30. Rotman School of Management, March 19, 200230 Example  Microsoft  The issue of capitalization of software development costs.  Does this strategy have a significant impact? © R.Elitzur

31. Rotman School of Management, March 19, 200231 Microsoft Income Statements © R.Elitzur

32. Rotman School of Management, March 19, 200232 The Magnitude of R&D Expenses in Microsoft © R.Elitzur

33. Rotman School of Management, March 19, 200233 The Accounting Art of War (Cont.) Manipulation of Valuation  Companies may want to increase reported revenues.  Example: MicroStrategy © R.Elitzur

34. Rotman School of Management, March 19, 200234 MicroStrategy  the Securities and Exchange Commission, when moving to crack down on lax accounting standards, in December 2000 has found that MicroStrategy Inc., an inventory-management software maker, was prematurely recognizing revenue. © R.Elitzur

35. Rotman School of Management, March 19, 200235 MicroStrategy Stock Price Accounting Change © R.Elitzur

36. Rotman School of Management, March 19, 200236 Sunbeam  A new CEO, "Chainsaw Al" Dunlap, was hired in mid 1996 to turn the company around. A year after he was hired, Al Dunlap Dunlap declared success in turning Sunbeam Corp. around in terms of profits and revenues.  It was later found that the revenue growth came from manipulation of revenues. © R.Elitzur

37. Rotman School of Management, March 19, 200237 Sunbeam (Cont.)  The company instituted an "early buy" program for gas grills in the fourth quarter that gave retailers the opportunity to buy grills in November and December of 1997 but not pay until as late as June 1998.  The company also started a "bill and hold" program that allowed Sunbeam customers to use its warehouses to store goods that they had bought, but not necessarily paid for. © R.Elitzur

38. Rotman School of Management, March 19, 200238 Sunbeam (Concluded)  Between them, these two programs accounted for a substantial part of Sunbeam's apparent revenue gains in 1997. In essence, these revenues were nothing more than future sales booked now. When this was found out the prices of Sunbeam Corp. shares plunged. © R.Elitzur

39. Rotman School of Management, March 19, 200239 Other Notable Examples of Revenue Manipulation  Rite Aid (inflated revenues in 1998 and 1999 by over US$ 1 billion)  HomeStore.com (booked US$ 54 million to US$ 95 million as ad revenue in the first three quarters of 2001 that it never received in cash but as a result of revenue swaps with advertisers for undisclosed goods and services). © R.Elitzur

40. Rotman School of Management, March 19, 200240 Off-Balance-Sheet Financing  Companies may want to omit debt from the balance sheet. © R.Elitzur

41. Rotman School of Management, March 19, 200241 Example of Off-Balance-Sheet Debt Enron  Motivation:Lower cost of debt to finance aggressive acquisition strategy.  Special Purpose Entities (SPEs). Debt omitted over $600 million.  Financial Instruments. Debt not shown on the balance sheet $1.5-3 billion. © R.Elitzur

42. Rotman School of Management, March 19, 200242 GE  Just recently (March 2002) General Electric Co. reported that it had off- balance-sheet SPEs that held US$56 billion of assets at the end of 2001, up from US$ 41 billion a year earlier. © R.Elitzur

43. Rotman School of Management, March 19, 200243 Kmart  Kmart has long-term lease commitments that had, based on my calculations, a present value around US $5.5 billion in 2000. When added both to the assets and liabilities of Kmart in 2000 it changed the debt to equity ratio from 1.4 to 2.3 and the debt/assets ratio from 58% to 70%. © R.Elitzur

44. Rotman School of Management, March 19, 200244 Air Canada  A similar exercise in Air Canada resulted in an addition of C$ 7.5 billion of assets and liabilities and a jump in the debt/equity ratio from 17.72 to 38.38. © R.Elitzur

45. Rotman School of Management, March 19, 200245 Adjustment for Off-Balance Sheet Leases - HBC (1999) © R.Elitzur

46. Rotman School of Management, March 19, 200246 Opportunism  Example: Air Canada © R.Elitzur

47. Air Canada Q2’01: Revenues hurt by economy, competition © R.Elitzur

48. Air Canada Q1’01: Difficult Economic, Cost Environment © R.Elitzur

49. Rotman School of Management, March 19, 200249 How Fastow/Enron Misused SPEs To manipulate financial reports and siphon off funds to Fastow & helpers until the company imploded. By Irene Wiecek

50. Rotman School of Management, March 19, 200250 Guiding Financial Reporting Principles  Economic substance over legal form – portrayal of reality Which assets and liabilities are part of the company? When is a transaction a bona fide transaction? Management intent  Arm’s length presumption - party is unrelated and bargaining on its own account – therefore price and terms fairly arrived at. Versus related party transactions – fiduciary responsibilities  Transparency – also a fundamental principle of efficient capital markets The difficulty with Enron lay with sifting through the complexity

51. Rotman School of Management, March 19, 200251 Decision making principles  All the relevant information available?  Quality of information i.e. based on reality, numbers reliable?  Understandable? “Enron’s SPEs were a mystery to most people at Enron”

52. Rotman School of Management, March 19, 200252 Economic entity concept - extends beyond legal entity Economic Entity Legal Entity Which assets & liabilities are part of the company? For Enron, the big issue was whether the SPEs were part of the entity

53. Rotman School of Management, March 19, 200253 Economic entity concept  Report on resources controlled by the company – where the company has the potential to reap the benefits but is also exposed to the risks  Consolidated financial statements recognize that even though there may be separate legal entities, together, they constitute an economic unit

54. Rotman School of Management, March 19, 200254 The Concept of Control  Continuing power to determine strategic policies without the cooperation of others  Spectrum No control Significant JointControl InfluenceControl Related parties

55. Rotman School of Management, March 19, 200255 Control Benchmarks  General presumption regarding control Normally – equity ownership >50% - must also prove control exists SPE – U.S. equity investment (at risk) >3% (now 10%), Canada >10% - must also prove control exists

56. Rotman School of Management, March 19, 200256 SPE Primer  Consider the following: Demonstrably distinct – cannot be unilaterally dissolved by transferor, outside ownership Restrictions on activities Legal form - may be corporation, partnership or trust SPEs are meant to be outside entities

57. Rotman School of Management, March 19, 200257 SPE Primer  Business reasons for creating SPE Economic benefits i.e. collateralize assets, share risk, obtain more favourable financing, cash out, Examples - synthetic leases, pools of similar assets (AR, mortgages, investments)  Wrong reasons get debt off financial statements, hide losses/risks, generally manipulate financial statements, “P&L protection”

58. Rotman School of Management, March 19, 200258 Enron’s SPEs Chewco/JEDI Syndicated investment Off balance sheet liabilities ($628 million), revenues recognized early, profits on own shares LJM Provided market for assets Artificial profits Equity overstated ($1.2 billion) LJM1/Rhythms Investment “hedge” Unrecognized losses ($508 million ‘97-’00) LJM2/Raptors Investment “hedge” Unrecognized losses ($544 million)

59. Rotman School of Management, March 19, 200259 Chewco/JEDI  Intent - JEDI Originally formed in 1993 with CalPERs to syndicate investment opportunities. Enron wanted to find another investor in 1997 so that CalPERs would invest in another vehicle.  Chewco formed 1997 as SPE  Nov 2001 – accounting reviewed and determined to be in error – consolidated retroactively

60. Rotman School of Management, March 19, 200260 Chewco/JEDI Kopper/DodsonDodson LP/GP Big/Little SONR River $11.4 GPLP $11.4 ENRON Chewco $132 LP Barclays GP $240 JEDI $240 + $11 +132 = $383 © I. Wiecek

61. Rotman School of Management, March 19, 200261 Chewco/JEDI Economic substance At issue Consolidate Chewco Part of economic entity?3% test not met due to $6.6 million cash reserves Kopper’s involvement Joint venture JEDI Part of economic entity?Equity accounting, full consolidation due to Chewco? Capital Transaction Jedi investment in Enron CS Non - eventCannot recognize gains on investment in own shares Revenue Recognition Guarantee fees, Management fee Fees for services over time Upfront/ early recognition Related Party Transactions All transactions Arm’s length?In best interests of Enron? I.e. Kopper received $10 million on repurchase and $2 million in fees

62. Rotman School of Management, March 19, 200262 LJM1/Rhythms  Intent – Transfer of risks/provide additional markets  Fastow GP – seek outsides investors  Formed 1999 - 20 transactions to 2001  Rhythms/Net connections Little market for CS (Enron had large holding). Worried about price risk.  Unwinding

63. Rotman School of Management, March 19, 200263 LJM1/Rhythms Fastow LP/GP ERNB/ Campsie LJM Partners Fastow $15 GP GPLP $1 LJM Swap LJM1 Co LP LJM GP Swap Sub 3%- test not met since negative equity © I. Wiecek

64. Rotman School of Management, March 19, 200264 LJM1/Rhythms 3.4 million CS Enron FV $276 ($168 discounted) ENRONLJM1/Swap Rhythms CS Sub $64Note $104Put option on Rhythms CS (Swap to $168buy Rhythms CS at $56) FV $104

65. Rotman School of Management, March 19, 200265 LJM1/Rhythms Economic substance At issue Consolidation?Part of economic entity? 3% test not met L > A; Fastow GP Hedging Put option on $5.4 million shares Rhythm True economic hedge? 68% prob that structure would default i.e. if Enron CS declined Related Party TransactionsArm’s lengthFastow’s involvement, payout skewed Unwind – large windfall to LJM1 $4.5 million to Fastow UnwindingArm’s lengthSettlement – value to Enron

66. Rotman School of Management, March 19, 200266 LJM/Other  Issues Selling to LJM assets that it could not sell elsewhere – subsequently repurchased Economic substance? Bona fide transaction? Guarantee against losses At issue – gain recognition

67. Rotman School of Management, March 19, 200267 LJM2/Raptors  Intent Syndicate capital investments Hedge Create markets  Fastow GP- Formed Oct 1999  Significant contribution to NI $1 billion 3Q 2000 to 3Q 2001  4 Raptors – 2 of which discussed below

68. Rotman School of Management, March 19, 200268 LJM2/Raptors Fastow/Kopper LP/GP 50 Limited Partners LJM2 CMLP $394 GPLP LJM2 $30 LP Talon Enron © I. Wiecek 3%- test unclear

69. Rotman School of Management, March 19, 200269 LJM2/Raptor 1/Talon Capitalization and $41 put $350 - 3.4 million CS Enron FV $537 ($350 discounted) $50 million note $41 million premium on put ENRON/LJM2/Talon Harrier LCC interest $400 million Note Put option on Enron CS – Talon to buy Enron CS @$57.50 © I. Wiecek

70. Rotman School of Management, March 19, 200270 LJM2/Raptors Economic substance At issue $41 million putIntent? Credit risk? Arm’s length Impact on 3% test Consolidation LJM2, Talon Part of economic entity? 3% test Fastow GP Investment in Enron Real transaction?Show NR as assets?

71. Rotman School of Management, March 19, 200271 LJM2/Raptor 1/Talon Total return swaps  Intent to protect Enron against losses on merchant investments  Enron pay future gains on investments to Talon  Talon pay to Enron future losses on investments  Locked in value on Enron’s books

72. Rotman School of Management, March 19, 200272 LJM2/Raptor 1/Talon Total return swaps Economic substance At issue Hedge Total return swaps Effective hedge? Credit Risk Dating of agreements

73. Rotman School of Management, March 19, 200273 LJM2/Raptor 1/Talon Costless Collars  Intent to shore up creditworthiness of Talon  If Enron CS fall below $81, Enron pays Talon difference  If Enron CS increases above $116, Talon pays Enron difference  Costless since premiums equal

74. Rotman School of Management, March 19, 200274 LJM2/Raptor 1/Talon Costless Collars Economic substance At issue Hedge Costless collars Effective hedge? Gains? Asset values Investment in Raptors Significant influence? Gains eliminated?

75. Rotman School of Management, March 19, 200275 LJM2/Raptor 3  Issues TNPC – held shares of the very shares that they were meant to hedge. Not presented to the BOD

76. Rotman School of Management, March 19, 200276 Things to think about  Business model – non standard transactions/changing business model  Intent - structuring transactions to achieve accounting objective versus economic objective  Narrow interpretation of GAAP - the 3% test – rules based versus principles based  Complexity – non-standard legal structures  Documentation – deal sheets, formal approvals  When the legal form becomes more important than the economic substance

77. Rotman School of Management, March 19, 200277 Enron’s Governance Structure Was Short Circuited Board Ken Lay: Chair; Co-chair ZZZ Audit, Compensation Cees. Management Lay, Skilling: CEO Fastow, CFO; Koppers Causey, CAO; Buy, CRO Watkins; Kaminsky; McMahon Company Policies Code of Conduct Internal Audit ? Whistleblowers ? Auditor Arthur Andersen Outside Law Firm Consultant: Arthur Andersen Missing Suspended Compliance Guidance Finan. Reports SPEs © L. Brooks

78. Rotman School of Management, March 19, 200278 Enron’s Ethical Culture  Code suspended, alternate controls ignored  Bogus trading floor for visiting analysts  Whistleblowers/doubters came forward (to), but Co-chair (Lay) resigned, 32 mil. … suicide? Kaminsky (Fastow) …….. ignored McMahon (Fastow)...transferred …now CFO Sharon Watkins (Lay)… Enron’s law firm found no problem …fox in the chicken coup  No protected whistleblower path to the Board  Do we need an Ethics Committee?

79. Rotman School of Management, March 19, 200279 New Board Responsibilities  Comprehensive Risk Management Broad understanding of business model Financial literacy Guidance & Control framework Focus on corp. culture, ethics & reputation Business ethics…whistleblower protection plan Ethics Risk Management  Trust, but challenge, don’t turn away Caremark National Case, trend © L. Brooks

80. Rotman School of Management, March 19, 200280 Comprehensive Risk Management requires understanding the business Risk Events Causing Drops of Over 25% Share Value, Percentage of Fortune 1000 companies, 1993-1998 Strategic ……………………………. 58% Customer demand shortfall (24)Competitive pressure(12) M & A Integration problems (7)Mis-aligned products (6) Operational …………….31% Cost overruns (11)Accounting irregularities (7) Management ineffectiveness (7)Supply chain pressures (6) Financial ………..6% [Foreign macro-eco, interest rates ] Hazard …….0%[Lawsuits, natural disasters] Source: Mercer Management Consulting/Institute of Internal Auditors, 2001

81. Rotman School of Management, March 19, 200281 Comprehensive Risk Management includes Ethics Risk Management Ethics RiskReputationSuccess Reputation is important  Arthur Andersen……………survival  RBC Dominion………reputational capital  Tylenol ……………competitive advantage Selling trust and credibility, not pills, … © L. Brooks

82. Rotman School of Management, March 19, 200282 Comprehensive Risk Management depends upon the Corporate Ethical Culture  Comprehensive Risk Management utilizes both: A. Key risk factor identification & measurement B. Review of key business processes including the ethical culture that underpins process integrity  Ethical culture provides guidance for employees about when to adhere to the Code, when actions are not covered in Code, in a grey area, or in a crisis - tools to measure ethical culture do exist Enron’s Board failed to consider any of this! Few corporations do A, fewer do B! © L. Brooks

83. Rotman School of Management, March 19, 200283 Audit Committee must  Understand key business operations  Understand comprehensive risk management model and reports  Examine key/large transactions  Ensure compliance with good policies  Ensure fair presentation Who wants this risk? How much should the members be paid? © L. Brooks

84. Rotman School of Management, March 19, 200284 Accounting Standards & Disclosure  FASB’s 3% standard was too low … now changed to 10%  Need rededication to: fair presentation, not specific rules orientation or pro forma illusions clarity transparency  SEC/IASC will be more evident… Can.?

85. Rotman School of Management, March 19, 200285 Audit & Professional Standards  SEC rules on non-audit services  More emphasis on professional ethics  Stronger enforcement/punishment for individual professionals: in accounting/audit firms in corporate clients  Is it in the public interest to shut down Arthur Andersen?

86. Rotman School of Management, March 19, 200286 Eric Kirzner: A Director’s Commentary  An eye-opening example from my experience  My criteria – must be met before I accept a Director’s post.  Tradeoffs a Director must understand  Process steps for a Director to consider

87. Rotman School of Management, March 19, 200287 Finance, Governance 1. AME HISTORY  Listed Montreal Exchange  Board: affinity people; friends of management  Going Private transaction Independent committee NOBODY: Management; board members understood!

88. Rotman School of Management, March 19, 200288 Membership Criteria My criteria for serving: 1. I am an expert in the field 2. The other board members: either experts, or knowledgeable and representing key stakeholders union reps on pension plans for example 3. No Cronyism

89. Rotman School of Management, March 19, 200289 Membership Criteria My criteria for serving: 4. Chair is expert, experienced and understands balance between unfettered debate and accomplishments.

90. Rotman School of Management, March 19, 200290 Membership Criteria My criteria for serving: 5. All functions in place  Management; internal audit and external audit  Independence of internal audit and management  Independent directors 50% plus?; public governor proxy Fee for service!

91. Rotman School of Management, March 19, 200291 Membership Criteria My criteria for serving: 6. Committee Structure  Governance  HR  Audit and finance  Risk management  Independent directors dominate committees?

92. Rotman School of Management, March 19, 200292 Understand Tradeoff Paradigm #1 DIRECTORS TO: “ Act in best interest of…” Company (statutory) OR Shareholders (regulatory) Paradigm #2  Maximization of Shareholder wealth  Paradigm #3  Public/ethical responsibility

93. Rotman School of Management, March 19, 200293 Process For Board Member 1. A Model Can you develop checklist of responsibilities Example: meet CDIC guidelines? 2. Committees Audit, HR, finance Appropriate trade-off approval and recommending

94. Rotman School of Management, March 19, 200294 Process 3. Board self-assessment Peer group review Chair review 4. Independent Directors; Public Directors Must understand everything Ultimate sanction of voting with their feet!94

95. Rotman School of Management, March 19, 200295 Comments & Questions  The Last Word Ramy Irene  Questions

96. Rotman School of Management, March 19, 200296 New Governance Series For directors and senior officers:  Director’s Responsibilities  Financial literacy  Guidance and control systems  Ethics risk management  Comprehensive risk management

97. Thank You on behalf of the Clarkson Centre for Business Ethics CC(BE) 2 & Board Effectiveness—CC(BE) 2 Executive Programs Rotman School of Management