Sarbanes-Oxley Section 404(b) currently requires all non-accelerated public companies to get an outside auditor review of internal controls, effective for companies with fiscal year-ends on or after June 15, 2010.  This means those non-accelerated filers who have previously received extensions to this requirement year after year, finally must comply with an internal control audit.  Or do they?

When discussing the current extension, which was granted October 2009, SEC Chair Mary L. Schapiro clearly stated “there will be no further Commission extensions.”  But in November 2009 the House of Representatives passed a bill giving non-accelerated filers a permanent extension to the auditor attestation requirements.   For the bill to become law it must be approved by the Senate and that is where it currently sits. It seems the possibility of the Senate passing the bill by June 15 is unlikely, the Republicans are not interested in reform and the Democrats have a weak effort to push the bill along.  If this bill passes at all, it will probably be later in the year.

So, what is the non-accelerated filer to do?  My advice to them, get ready for a controls audit but wait one more month to bring in the auditors.  If the SEC Chair goes against her own words and issues another extension, it will be granted very soon to affect the June filers.  

The small public filers have been complying for years with the management assessment requirement of Sarbanes-Oxley Section 404(a) and should have key controls defined and assessed, ready for audit.  If this documentation is less than formal, make sure to document those controls now.   Bring in the auditors in Q4 if, and when, attestation is assured.

We certainly live in a world of clichés, inspirational mantras and advertising slogans.  “Time is money.”  “All is fair in love and war.”  “You are what you eat.”  “Just do it.”  “Serenity now.”  While I appreciate the wisdom of Frank Constanza, I tend to avoid clichés as a rule.  I just can’t rally around a poster of kitten hanging from a branch to inspire me to “hang in there.”  But I do consider myself a man of faith and do believe in some words to live by.  One of my favorite quotes, that I keep in right near the tip of my tongue in tough times or points of inflection in my life, always seem to inspire me.

“It is not what you know but what you do with what you know that makes a difference.”

My twin brother Rocco had this quote under his picture in our senior class yearbook.  I have always liked it for not only this personal reason but because it crystallizes my position many things, especially the difference between intelligence and smarts.  It is clearly personified in the hundreds of entrepreneurs who have harnessed a good idea into a great company.  The two are not as highly correlated as you might think.

From the early technology entrepreneurs of Edison and Tesla, inventors parlayed their patents into financial success, some more than others.  Edison left a legacy of stature and wealth while Tesla died penniless.  Look at any successful technology company in the world today and you rarely find the “first mover” as the market leader.  Microsoft created the first operating system for personal computers for IBM’s PC but retained the right to market MS DOS separately.  Google was maybe ninth to the table for web based search.  Apple certainly wasn’t first to the party for personal computers but has certainly adapted well and survived based on its ability to understand the consumer.  Check this picture of the Apple II from 1977!

The current class of successful entrepreneurs have taken a basic concept (let’s say people getting to know each other), applied technological solutions already in use (networking, web interface, security), created an application for a specialized niche (oh, I don’t know, maybe college students at Harvard University) and  then gave the world Facebook.  At the time it was founded, February 2004, the world already had Napster, Friendster, MySpace and LinkedIn.   Then, a few years later in 2006, an upstart comes along with a business model based on a word that founder Jack Dorsey found in the dictionary to mean “a short burst of inconsequential information.”  Twitter was born and like the word “Google” has become engrained into our hip technology vernacular.

The common denominator in all of these success stories is the ability to see a good idea as the beginning of a great company.  Throw in some bravado with realistic humility (knowing your limitations and hiring or partnering with the team that can get you to the Promised Land) and you see the difference between inventors and entrepreneurs, intelligence and smarts, Einstein and Tesla.  Sure, some, if not most, of this recipe for success is the ability to market and sell a product (Sony’s Betamax was a much better format than JVC’s VHS but we all know who won the video format war.)  But a successful idea learns to live and breathe on its own.  In my world of discounted cash flows, the value of an idea will only have a terminal value equal to what it would take to recreate it.  Build a successful company around it that can generate cash flows, intangible assets such as brand, customer relationships and goodwill and this success will change lives and build legacies.

In my other world of wine and spirits, I leave you with another success story; “When life gives you lemons, make Limoncello.”

In the dynamic world of audit and audit related services an often overlooked benefit is the risk assessment process. In the world of the Internal Auditor it’s not only used to create the annual audit plan; the risk assessment creates a flexible framework to identify the keys to achieving an organization’s success. The process to create the framework, if done properly, should help build consensus across organizations, enable executive management to make more informed decisions and foster greater cooperation on audits.

The complexity of risk assessments is tied to industry and Internal Audit department maturity. An established IA department in a heavily regulated or highly complex industry, like banking, may use more complex risk assessment processes and tools. To contrast, a recently formed IA department for a retailer could most likely execute the risk assessment using Word and Excel. In both cases the final results are the same; a risk based assessment of a company’s processes.

Executive management, as always, plays the pivotal role. Think of the framework as the picture of a company. Individual’s pictures vary depending on level and position and it’s the CAE’s responsiblility to co-development with management a picture that fits (on at least some level) into a picture that everyone can easily understand. This is the basis for communication regarding risk, controls, how the company’s strategy ties into the framework, and the risk assessment results. When executive management understands the risk assessment framework and process they are more likely to support audits of sensitive areas and in some cases, actually ask for audits for processes under their supervision.

Without sounding schizophrenic, I live in two different worlds.  No, I don’t have a secret Avatar life; but I do claim some expertise in two very different industries.  I lead valuation engagements for technology companies and wineries.  Sounds a bit strange, even as I write it, but it makes absolute sense to me.  Let’s take a look at the obvious differences before I enlighten you on the not so obvious similarities:

Differences

1. Assets – This may not be the most obvious difference to most, but to me it is the biggest difference between these two industries.  While a winery’s brand is at times its strongest and most valuable asset, a winery’s day to day focus is on real, tangible assets that someone can come in and count and touch with their own hands: cases and barrels of wine, land, machinery and equipment for crushing, pressing and storing wine and that old Ford truck the head wine maker drives.  A technology firm’s assets are much more intangible: software code, patents, that little “Intel Inside” logo on every computer.  A technology firm’s assets walk in and out the door every day and intellectual property is by far the biggest driver in this industry.
2. Owners – The wine business is one of the few remaining family generational industries.  The owners usually see their last name (or maiden name) on the product they sell and don’t venture too far off the family tree for investors or other owners.  Technology firms are rarely family owned.  They are mostly venture capital funded and ownership is shared among the entire employee base; everyone has skin in the game in most technology firms.  
3. Transparency – It seems like benchmarking in the wine industry is only done on the very rare occasion in broad and vague language by winery owners over a glass of cabernet at a charity auction.  Most wineries don’t know what their competitors are really doing in terms of sales, margins, spending by category or profitability.  In all honesty, I think that every winery would love to be able to benchmark themselves against others in their industry, but only under the condition that they don’t share their own information.  The technology industry embraces transparency and benchmarking because both facilitate the life blood of private and public capital investment.  For example, real and significant value is placed on audited financial statements when you need to file a prospectus with the SEC in order to do an IPO or a private placement memorandum.

Similarities

1. The People – Both industries, especially here in California, are home to some of the most passionate and brightest business men and women our country has to offer.  A good percentage of the world’s best wine is made within a 30 mile radius of my office in St. Helena, California.  And some of the greatest entrepreneurs the world has ever seen live and work within a 30 mile radius of our firm’s headquarters in Palo Alto, California.  Northern California hasn’t cornered the market on passion in the workplace but it is surely a common denominator for successful firms in both the wine and technology industries.
2. Consumer Focus – Yes, this one may seem simple but people who buy iPods also buy a Napa Valley Cabernet Sauvignon.  The focus of both industries is the end consumer and creating and enhancing a lifestyle that is both technologically savvy and appreciative of the good things in life.  While the wine industry has been slower to embrace technology, the overlaps between these two industries is becoming clearer with the use of social networking and the slow embrace of software tools like CRM (Customer Relationship Management) software.
3. Zero Revenue Models – This one isn’t so obvious.  However, during my professional life in both worlds, I see a strong similarity between startup wineries and technology firms.  Both have very similar characteristics with respect funding early stage losses for long-term gains.  A piece of unplanted land in Napa Valley has similar business model hurdles to a life science startup in Silicon Valley.  The only difference is that the investment for the winery is in tangible assets (planting vines, building a winery and tasting room) while the life science startup invests in people in the form of research and development, usually out of a sublet, non-descript commercial office.  Both business models require patience (it can take up to seven years, depending on the varietal, to see any revenue from newly planted vines) and regulatory hurdles (there is about a 10% probability of getting a drug from clinical testing to FDA approval).

So, where do all these differences and similarities get us to?  Good question.  We believe that the answer is in the form of our new blog; Crushing It!  Derek Groff (who also lives in both worlds) will take command of a new blog over the next month that tackles some of the following topics:

1. Stock Option Plans – Do they make sense in the wine industry?
2. Virtual Wineries – How do they work and why is it the right path for some winemakers?
3. Technology – Will the industry embrace technologies that can improve the quality of wine, reduce a carbon footprint and enhance processes and controls?
4. Winery Valuations – What are wineries worth?  What are the impacts on generational transfers?  What drives value?
5. Alternative Sources of Capital – In an industry dominated by family-run businesses, how do wineries obtain capital in the form of private or public equity and alternative forms of debt?
6. Benchmarking – Yup, we’ll try to tackle this one with some interesting observations and well-thought out suggestions.

Sound good?  Tune in here soon for Crushing It!

Communication skills are dynamic and in the business environment they are very difficult to measure and are often undervalued. Effective communication not only minimizes time, cost and workflow, it also leads to increased client satisfaction. Communication includes tone, style, and format and is most often the determining factor in failed audits. Here is the problem; people communicate differently from one another and often times are polar opposites. Below are a few thoughts on communication protocols and communication styles.

A strong service delivery methodology lays the foundation for an audit team to communicate consistently and effectively across all engagements. Key steps that include a scope meeting and standardized documents like the scope memo create structure and are tools of communication between the audit team and business owners. For example at an audit’s inception the audit objectives, high-level procedures, and deliverables are documented and agreed upon. With a clear understanding held by both the audit team and the business owners the likelihood of the audit succeeding is vastly improved.

Communication style includes format and tone and is the second key to executing audits, especially Internal Audit audits. In most instances a formal report is written and presented to executive management, the BOD and possibly the actual business owners. However, at each level there is a different style of communication with varying amounts of detail. For example, typically during the course of an audit smaller findings are not included in the formal report. These informal findings often times are communicated verbally to the business owner, but not necessarily to executive management and probably never to the BOD.

Be careful with Email! Email is not the preferred method to communicate issues, especially technical issues. First, let’s not confuse email with a formal written report. The processes to write an email compared to an audit report is the difference between making a paper airplane and a real one. Emails are also more difficult to control. I don’t know how many times I’ve seen simple issues turn into catastrophes because either an email was written in haste or misunderstood. Often times it was a combination of both. As an auditor a little courage must be exercised to pick up the phone or conduct a meeting to discuss issues face to face.

Without the proper protocols or effective means of communication Internal Audit projects can become painful experiences for both the auditee and the auditor. With them, sucess is more likely and easier to achieve.

Alright, I admit it, I didn’t think that I would get myself excited about these resolutions but to my surprise, they are keeping me busy.  I can honestly say that, with a smile on my face, these goals have already impacted my personal and professional lives.  Here’s how:

1. Invest in my Network – Following my own advice, I responded to a friend’s introduction to a job seeker with the invitation to meet and discuss his search.  I took the rational approach that I can’t recommend anyone I didn’t know or at least had met in person.  After meeting with him and confirming my original thought that he was someone I could recommend to my network, I got to work and facilitated three good leads for him that may lead to a specific opportunity but will certainly strengthen his network.  I have followed up on two other ideas to introduce good people into my network and “pay it forward” with solid opportunities for them to follow.  Regardless of what I get back in tangible leads or opportunities, my return to date has been simple.  I feel better about myself.  The rest will come in due time, if it comes at all.  At this point, the smile on my face doesn’t require much more support to stay there all day.
2. Ask the Question – OK, it may be a form of self-promotion (I have told several people to check out this specific resolution on my blog) but I have used this resolution at least a half dozen times including twice this morning.  I go into my enthusiastic “rant” that the only way to get a “yes” is to ask the question (bringing up the Wayne Gretzky quote that “You miss 100% of the shots you don’t take”) and I get immediate buy-in.  Without knowing it at the time, the statement crystallizes a logical and simple default that has worked wonders for me over the last three weeks.
3. Be Prepared – Nothing has really changed in my life over the last month on this one.  My scout training has always kept this default in my everyday life.  I hope that it is for others. 
4. More Balance, Less Juggling – I still haven’t worked out in January (I’m hoping to head to the gym tonight!) but I’m trying hard to keep this balanced approach front and center.  It is a bit harder at home with overactive 5-year old twin boys and a barking dog but my wife and I certainly see this default as the ultimate goal and continue to strengthen our partnership in being on the same page in getting there.  At work, I continue to work with my team and get them more responsibilities that, in the end, will create greater team balance and less fire drills.
5. Enjoy the Moment; then Move Forward – I’m working on this one as well.  No real specific successes in the last few weeks to savor other than the smile on my boys’ faces, the twinkle in my wife’s eye and the soulful enjoyment my dog gets in trying to give me a kiss.  I’m loved at home and respected at work and I have been enjoying these special moments knowing they will continue to come with hard work and appreciation for what I have.  Philosophical; yes.  Sappy; maybe.  The right way to live each day; absolutely.

More to come; let me know what you think.  Email is jorlando@frankrimerman.com.  Remember, “there are no stupid questions.”

I’m not in the habit of sticking to my personal resolutions each year.  The list always seems to be the same (lose weight, exercise more) and the effort usually breaks down by the middle of January.  However, this year, I’m refining my list to one that is both personally and professionally focused and includes goals that I can get excited about and embrace throughout the year.  Here it goes, my top five resolutions for 2010:

1. Invest in my Network – Having been on both sides of the “job transition” table in my career, I know how tough it is to find a job when you don’t have one.  My goal is to leverage my personal and professional network to sniff out opportunities where I can recommend good people who are currently out of work or looking to move on to new challenges.  What better return can you have on “investing” in your network than putting a qualified friend or previous co-worker in touch with a personal or professional contact who is looking for good people to hire?  A positive recommendation can strengthen the relationship and only make you look better to that individual and his/her firm.  The investment has risk (there may not be a match or, once hired, they may leave for another job after 6 months) but if you spend the time to think through the circumstances and potential for a match before you make the connection, the downside is minimal.  I successfully buy gifts the same way.
2. Ask the Question – While I try to live by the rule a high school teacher instilled that “there are no stupid questions”, reality has set in over the last 25 years and I found out that the world is full of them.  And sadly, there are answers to these stupid questions.  Sign up for a twitter account to find out the answer to that all-important question; what is Paris Hilton really thinking about today?   The trick to “asking the question”; having the confidence to ask it and not being afraid of “no.”  Can we set up a time to meet to discuss our firm and services that may be right for your company?  Are there any clients who you would feel comfortable recommending me and our firm?  What can we do to help you?
3. Be Prepared – Yes, the Boy Scouts of America motto.  As an Eagle Scout (once a Boy Scout, always an Eagle Scout), I sometimes live my life like I’m preparing to cook dinner over an open fire.  Have a menu and a plan but be prepared for anything and adapt to the conditions.  Preparing for any situation requires a combination of flexibility, confidence, humility and perseverance.  It doesn’t require thinking through every scenario in our head to the point of being overwhelmed.  This advice to myself means going into a meeting with an agenda, goals and planned takeaways but having the ability to ride the wave of conversation and go off point every now and then when needed.
4. More Balance, Less Juggling – I believe that balance requires an understanding of the big picture and juggling requires a focus on everything at once.  Watch a five year old ride a bike.  When they stop focusing on pedaling, steering, stopping, ringing the bell and looking ahead all at the same time, they move away from the requirements of the task and start riding the bike.  I continue to believe that balance in life requires a step outside the box, a walk around the block and sometimes a soundtrack to sing along to as we work and play.  There will always be deadlines and fire drills at home and work that make life hectic; understanding the big picture allows us to take a deep breath, ride the bike and have some fun.
5. Enjoy the Moment; then Move Forward – Success is a series of little victories that guide us down a path we hope to follow.  I often see these little victories as a means to a bigger end.  What I don’t do as often as I should is enjoy the victory before I move on.  I don’t think that it is selfish or inappropriate to do something extraordinary and then step back and tell yourself; “good job.”  These moments should be savored and they are the glue that makes our eventual success stand the test of time.  And the best victories are the ones we share with friends, family and co-workers.  Moving forward should focus on the “end” but recognize the “means” as the breeding ground for confidence, fun and eventual success.

That’s it.  I will let you know how closely I stick to these over the next 12 months.  May we all have a happy and healthy 2010.

In 2010, SOX as we know it may undergo a dramatic change.  There are two pending events about the Act that directly impact who it affects and how it is administered.  The first may eliminate a large number of companies that need to comply with the section 404(b) of the Act; the other may restructure the Act all together.

The first topic deals with businesses below $75 million in market capitalization and their requirement to comply with section 404(b), the requirement for independent auditors to attest the effectiveness of management’s assessment of internal controls.  In October 2009, the SEC once again extended the deadline for non-accelerated filers to comply with section 404(b) to June 15, 2010. This deadline, though extended numerous times in the past, is said to be the last extension.  However, due to recent legislation passed by the House Financial Services Committee, non-accelerated filers below $75 million in market capitalization may be exempt from 404(b) permanently.  There is still a long way for the amendment to pass the full House and Senate, and as with any anti-regulatory legislation, there are numerous pros and cons that come with it.

The pros are clear, if passed this piece of legislation will provide financial relief to smaller businesses from a requirement that has already been extended a handful of times and that provides a disproportionate cost.  A recent SEC Advisory Committee report noted that in 2004 companies with revenues over $5 billion spent .06% of revenue and companies under $100 million spent 2.55% (SEC report pages 33-34.) The cons are also compelling. The proposed amendment may reduce investors’ confidence in and increase their chances of fraud.  These combined may reduce investor activity in small public companies and further reduce their chances to raise capital. 

The second, more controversial topic is the Supreme Court case Free Enterprise Fund v. The Public Company Accounting Oversight Board.  At issue is whether or not the PCAOB created by the Act is constitutional.  The main argument of Free Enterprise Fund is that since the SEC appoints the board members, the President does not have adequate control over the Board as the Constitution requires of all Executive Branch agencies (i.e. violates the separation of powers between the Legislative and Executive branches).

Supporters of the Board say that the SEC has long since used the services of private self-regulatory organizations similar to the PCAOB such as the New York Stock Exchange and the Financial Industry Regulatory Authority.  They claim the Board is not an independent agency, but rather an entity that functions under the complete control of the SEC.  People for the reform of the Board, such as the Free Enterprise Fund, say that the Board is in fact independent from the SEC because the SEC can only remove members for cause as oppose to at will. A recent Wall Street Journal article sheds more light on the subject.

The impact of the potential changes is debatable.  However, it does open a Pandora’s Box to allow legislators a chance to create additional amendments to the Act, such as shielding banks from the fair value accounting requirement.   

The decade started with the bursting of the dot-com bubble and a litany of corporate scandals that led eventually to the creation of SOX.  2010 is lined up as a pivotal year to how U.S. public companies operate.

In my previous blog post I wrote about Internal Audit’s (IA’s) effectiveness. As a follow up, I thought I would write about a related topic, value. Just as IA varies between companies, so does the definition of value. IA’s value is situational and it changes as IA matures, varies by industry, and is directly related to a company’s risk appetite. Examples of value include; realized (or identified) financial recoveries/savings, increased productivity, more informed corporate decision making, and compliance with policies, procedures, laws and regulations.

Because each IA department’s value is situational it’s virtually impossible to describe all the potential definitions. Here are a few examples.

Fraud prevention. Take for example a multi-national company with business units in emerging economies; fraud prevention or strong anti-corruption practices is what may add the most value. The Foreign Corrupt Practices Act (FCPA) is not new, but with fraud cases (both in numbers and in value) on the rise it’s a focus of our government (e.g. Department of Justice, FBI, etc). The cost of potential fines and prolonged investigations is potentially very large, but also think about the impact to a company’s corporate image and eventually its stock price. Here is one recent case example from the Department of Justice (DOJ). IA can provide a perspective on the effectiveness of the compliance control environment and help prevent problems from occuring.

A common understanding of risk. Compare the situation above to a small retailer that has just created IA. The completion of a risk assessment is a building block to a successful IA department. The risk assessment process includes multiple interviews with key process owners using established risk rating criteria to create a comprehensive risk profile. The value: knowing what the key processes are to achieve the company’s strategic goals and having a common understanding of risk among the many stakeholders (executive management, process owners, BOD, etc).

Training. Whether it’s a store audit program or a FCPA compliance review, a successful compliance audit program should be designed to provide more than a perspective on the level of compliance. It should serve as a training opportunity for all of those involved. When a non-compliance issue is noted, it’s the perfect opportunity for IA to communicate what is wrong, what’s correct, and the most important, provide a perspective to why compliance is important. Employees are stretched thin (especially in times like these) and the importance and reasons for compliance related processes is often forgotten or lost in translation.

The word value is nebulous. What adds value to one stakeholder can be virtually useless to another and it’s up to the CAE to work with his/her stakeholders to co-develop the definition. Feedback from internal business partners, the audit committee, senior management, and peer departments, provides a comprehensive perspective from which the CAE can tailor to their specific situation. By co-developing the definition of value IA awareness is increased across the organization and the department’s vision is further vetted. So, what is your IA department’s value?

As far back as 2007 (almost two full years ago!) when a bailout meant borrowing $1,000 from a buddy, the New York Times estimated in an article that “it is estimated that 1,000 people each have more than $5 million worth of Google shares from stock grants and stock options.”  At the time of the article (November 11, 2007) the stock price hovered around $665 per share.  It currently trades at around $575 or a decline of approximately 13.5%, which brings that $5 million down to a paltry $4.3 million.  However, over the last 12 months, the stock dipped to as low as $250 a share so hopefully these same employees got more options at lower prices to help soften the blow.

At the time, there were over 16,000 employees at Google, half of which had worked less than 12 months at the company.  Imagine if you worked at Google as one of the “unfortunate” employees to have options worth only $1 million.  I could see walking the halls with some of these thoughts going through my head;

1. Why are these people still working here?!
2. What possible incentive do any of us have to come into work every day?
3. Does this financial security put the company at risk when any one us us can just “retire” at any time?
4. Was Notorious B.I.G. right; mo’ money, mo’ problems?

I (and I’m sure many others) could also look at this situation in a much different way;

1. I work with “partners” who want me to have skin in the game and are incented to see the entire company succeed.
2. We are in control of our own financial destiny; as the company rises, we rise along with it.
3. My role at this company is a career and not a replaceable job based solely on salary.
4. I will do everything I can to spread the good word of our company to the rest of the world.

I am a big fan of stock option plans and not for the obvious reason that our practice is hired to value the per share common stock values of private companies for the purpose of granting options (IRC 409A).  I am a big fan because strong, professional managers gravitate towards companies that share the upside of growth and prosperity with their employees.  As simple question; would Google be Google if its stock option plan didn’t trickle down to every employee?  Said another way; what makes Google a market leader?  Answer: its people.  I strongly believe that in a hiring situation where a strong candidate has two similar opportunities, he/she will always pick the one with the better stock option plan and not for just for the financial upside but for the simple fact that top management wants its employees to share in its good fortunes.

On the flip side, in the current market environment where struggling firms need professionals with the ability to turn around a difficult situation, the upside (i.e. lower strike prices on options and possibly more actual share grants) is even greater.  Clearly, within the technology industry in San Francisco, Silicon Valley and the South Bay, option grants influence hiring decisions and strong management teams for both quantitative and qualitative reasons.

However, these plans don’t come without risk.  Anyone who has worked at a public company whose stock is going in the wrong direction knows the impact stock price has on employee morale.  It is sometimes the last straw for employees to jump ship (“my options are out of the money anyway”).  These logical responses fueled by simple human nature may lead to high turnover, poor work quality and low efficiency, which can spiral an already bad situation to one beyond repair.  Add in the nebulous nature of private company stock options where exit opportunities aren’t a matter of calling your broker and you can see why some industries don’t employ these plans at all.

Over the next few blogs, I will discuss this topic within a predominantly family run industry that has little to no support for these plans: the wine industry.  With very few public companies and an industry predominantly comprised of multi-generational, family run wineries, these plans may not make sense.  Or do they?