Directors’ Exam: Old Dog with New Tricks
Looking for a training tool to better inform your Board of their fiduciary responsibility of governing your bank? Tired of paying those external audit fees (which seem to increase every year) for conducting an audit that produces few changes and results only in a pretty set of financial statements? Want to better engage your management team in the processes of financial reporting, corporate governance, and operational awareness?
If you have answered “yes” to one or more of these questions, consider this “Old Dogs with New Tricks” idea that has found itself mostly in the garbage heap of current banking practices – a directors’ exam. Now you might say that this is teaching a New Dog Old Tricks because each of you knows bankers who still utilize a directors’ exam in lieu of an external audit. And that would be true. However, I am not referring to delegating the responsibility to outside parties; but rather the original, genuine, authentic exam actually produced and performed by the directors themselves. How do you think the exam got its name?
Yes, many years ago in banking, the directors of the bank performed certain procedures, usually as of year-end, to determine that the financial records of the bank were accurate. This involved counting cash drawers and vaults, confirming loan and deposit balances, inspecting real estate, inventorying official checks and travelers checks, counting desks, chairs, art, equipment, footing notes, reconciling banks, counting securities (yes, there really used to be securities you could physically count) etc., etc.
Several months ago I was approached by one of our clients that outsources internal audit operations to our firm. The desire of their Board was to step down from an external financial audit that had been performed for many years and involve their own Board to perform a directors’ exam. They asked for our assistance with planning, general oversight, work paper documentation and financial statement preparation; but all procedures would be assigned and completed by a director.
Admittedly, I was a little skeptical. OK, a lot skeptical. Although directors’ exams are not that uncommon, I had not seen this idea practiced in a long time, a really long time. But this Board was determined and we agreed to go along for the ride. Their primary reason was to better inform each director of bank processes. Also, the Board, being very familiar with much of the customer base of the bank, felt this was a good opportunity to assist management with the directors’ intellectual capacity in regards to those customers and the community.
And it worked! It wasn’t easy; it took time; it took persistence. But when all was said and done, the entire Board agreed that the process was very enlightening and beneficial, produced constructive change, and challenged existing policies in their application from both a substantive and procedural aspect. They are already talking about a repeat performance for next year. Assignments will be rotated to give each director a different area than the year before.
Now, before we go any further, what about your regulators? What do they think about this?
First, Section 36 of the Federal Deposit Insurance Act requires insured institutions with $500 million or more in total assets to have an external audit of their financial statements. So, if your institution is $500 million or more in total assets, this idea is not for you.
Second, the Federal Financial Institutions Examination Council (FFIEC) has adopted the “Interagency Policy Statement on External Auditing Programs of Banks and Savings Associations.” The other banking agencies have also adopted the interagency policy statement. Among other things, both the interagency policy statement and the rescinded FDIC policy statement encourage institutions to adopt an annual external auditing program. The interagency policy statement states that the banking agencies consider an annual audit of an institution’s financial statements performed by an independent public accountant to be the preferred type of external auditing program. However, the statement also describes three other alternatives to a financial statement audit, one of which is an agreed-upon procedures examination performed annually (commonly called a directors’ exam). The policy statement reminds boards of directors that they are responsible for ensuring that the external auditing program is appropriate for their institution and adequately addresses the financial reporting aspects of the significant risk areas and any other areas of concern in the institution’s business. The policy statement also instructs institutions to provide copies of reports pertaining to the external auditing program to the banking agencies and any state authority.
Simply put, you know your regulator and they know you. While the FFIEC statement permits the directors’ exam, I suspect you have a good idea whether your regulator would smile or frown on this practice considering your recent track record and individual situation with them.
Yes, I was skeptical. I suppose it was the auditor in me. But the experience was unique. The Board members, no doubt, developed a deeper understanding of bank operations and improved their capacity to fulfill their fiduciary responsibilities.
Hey, maybe we should give a little more credit to those “old-timers.” By the way, did I mention that the bank saved over 35% of their external audit fee from the year before? (Shhh! That’s not why they did it.)
