Who Should Internal Auditors Report To? How This Very Important Function can be More Effective.

An article published in CFO.com on October 13, 2006 by Sarah Johnson entitled "Should Internal Audit Report to the CFO?" reports that Moody’s Investor Service issued a “best practices for audit committees’ oversight of internal auditors” which recommends that such internal auditors not report to the company’s CFO but instead the CEO and the independent audit committee of the Board of Directors.

Currently the practice is to have the internal auditors report both to the Chief Financial Officer and the Audit Committee of the Board of Directors. Explaining their recommendations according the CFO.com article:

"It creates a potential conflict if the internal auditors report directly to the CFO," says Dave Roberts, president of the Institute of Internal Auditors and a member of the city of Orlando's audit committee.

I respectfully disagree with Moody’s recommendations in that they do not solve the overall problem of potential conflicts of interest.

I wrote a response published on CFO.com’s web site which said:

“I believe this idea of having the internal auditors not report to the CFO is sound. However, as a former CFO (who participated in the Crazy Eddie fraud with my CEO – Eddie Antar) I believe we should take it a step further and have the internal auditors report directly only to the Audit Committee of the Board of Directors and not the CEO too.”

The internal auditors must report only to the independent Audit Committee of the Board of Directors since in most cases frauds committed by CFO’s also include collusion with the CEO – WorldCom, Enron, Crazy Eddie,etc.

I made an additional recommendation in my comments published on their web site:

“In addition I believe that similar to the way States certify and license CPA’s, we must have a similar accreditation of internal auditors. They must be licensed. The effect would be to raise the level of professional responsibility and stature for this very important profession.

Furthermore, the certification of financial reports by CEO’s and CFO’s should be expanded in that any person in the corporate hierarchy that makes representations to the external auditors must certify their information in some form.

If for example, internal auditors were licensed by the states they practiced in and certified their reports to external auditors it would raise by default their level of responsibility, accountability, and create greater awareness of the serious work they perform.”

I believe that my recommendation's set forth above would result in meaningful results in increasing the integrity if financial information which is the life-blood of our great capitalist free market economic system.