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ISA Chairwoman, Anat Guetta: Is the CFO a gatekeeper


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TheMarker economic newspaper –  CFO’S Conference

ISA Chairwoman, Anat Guetta: Is the CFO a gatekeeper?!

Good morning.

I am very happy to be here today, to personally meet and speak to one of the ISA’s most important direct client groups – public company CFOs.

CFOs are a critical factor in preparing a company’s financial statements, which is the most important information available to the investor public who are considering investment decisions. And of course, the ISA is the entity that regulates the quality of this disclosure.

As someone who was not “born” as a regulator, and instead joined the ISA after many years in the market, I strongly believe in a direct relationship between the regulator and the regulated entities.

My main goal as ISA Chair is to enable the operations and further development of a fair, safe public capital market in Israel. On my view, this goal cannot be achieved without an understanding of the market and what really goes on on the “shop floor” – the incentives, pressures, constraints, and power relations, or in other words – life as it actually is.

That is the reason that I make sure to meet with the various market players on a regular basis, and encourage ISA employees to do the same. The regulator and the regulated entities are both sides of the same coin, and both share an interest in maintaining a strong, efficient, attractive, and trustworthy capital market.

That is why I am happy to speak to you today.

Today I would like to talk about the CFO’s role as a gatekeeper in his or her company, and will use the next few minutes to introduce this issue.

What is a gatekeeper?

Does the fact that the CFO is a key factor in preparing a public company’s most important information (its financial statements) contribute to her status as a gatekeeper?

At the outset we should clarify that a gatekeeper is not a legally defined term in the Companies Law or in the Securities Law — in contrast to the terms “interested party” or “controlling shareholder,” for example. In fact the term gatekeeper does not even appear in these laws. The Supreme Court interpreted the term “gatekeeper” in a corporate context as “the complete array of professional functions outside the corporation… which include… analysts, rating companies, underwriters, and others, whose function is to protect the interests of the investor public by making available reliable information on a corporation’s financial position.”[1]

According to this interpretation, a gatekeeper is a function external to the company.

Another decision by the Economic Department of the District Court, however, states that in the context of examinations of financial data, a gatekeeper can also be “an officer, director, or auditing accountant”[2] — which means that the list of gatekeepers is not limited to external functions.

Honestly, though, I believe that the debate about the precise legal definition of the term is less important. The most important thing is to study and understand the essential nature of the CFO’s function, CFO’s responsibilities and powers, and derive the CFO’s duties from these rather than from any legal definition.

Such an essentialist examination reveals what you all obviously know very well: that the CFO is the senior financial function in a company, and as such is responsible for accurately preparing and presenting the company’s financial information in a timely manner. The CFO is the main function that has the power to ensure that a company’s financial statements — and effectively, any report that contains the company’s financial information — is accurate, reliable, allows comparisons, and conforms to high standards. Market analysts trust the financial assessments that the CFO publishes on behalf of the company including its projections and probability of realization. It is the CFO whose integrity is critical in ensuring that investors to continue to participate in the company’s future capital raising rounds, which constitute a safe and convenient source of financing for the company compared with other more expensive alternatives. The CFO clearly does not carry the burden of that responsibility alone: He or she shares it with the management and board of directors.

That is the reason that the law imposes on public company CFOs (and on their CBODs and CEOs) personal responsibility for the contents of the financial statements, which the CFO signs as the senior officer in charge of the company’s finances. Obviously, in the event of a violation of the law, this responsibility can be translated into a criminal, administrative, or civilian proceeding, as relevant.

Court rulings indicate that the CFO’s obligations concerning the accuracy of the financial information also apply to other financial reports that are a core part of the CFO’s work.[3]

I would like to dwell on this point for a moment.

The CFO of a public company must verify that the financial statements reflects the true state of the company’s business position. Financial statements are not — and should not be treated as — documents drafted in a vacuum. They must faithfully reflect the business reality of the company in question.

I should note that IFRS standards, which, as you know, are principle-based accounting standards, leave much room for discretion, and therefore they may occasionally become fertile ground for improper practices. And this is exactly where we place emphasis in our examinations.

To illustrate, let me give you some examples of improper accounting treatment that misrepresents the true nature of a business action:

  1. Using estimates that have a tenuous relationship to reality;
  2. Presenting a semblance of a stable financial position when a deeper examination of the data shows that this is not the case.
  3. Presenting a semblance of control when this is not the true situation;
  4. Presenting an inventory balance of little value;
  5. Presenting accounts receivables that have little chance of being paid;

and so on and so forth…

And now I am telling you that under my clear instructions, the ISA is going to delve more deeply into the activities of the gatekeepers and the discretion they use. It is there that we are investing extensive resources, because in my view these are the most sensitive spots.

What distinguishes the CFO from other corporate officers is that all the company’s financial information as well as its operating and business information, are channeled to the CFO. The CFO is at the crossroads of these two streams of information, and it is the CFO’s job to translate the company’s business operations into numbers. The CFO mediates between the company’s operations and their presentation in its financial statements.

For example, the CFO of a construction company receives reports on various projects and their progress from the budget control department, and must translate this information into monetary terms – by determining the amounts that will be recorded as income and expenses. The CFO determines what is included and what is excluded from the financial statements: should an asset be recorded, should a provision be made, and many other such determinations.

As a critical contributor to the construction of the financial statements, I expect CFOs to identify risk factors and ensure that the financial statements represent the company’s business situation in a fair and reliable manner.

You certainly understand the significance of financial reporting that lacks credibility and its impact on the market and on investors — if that ever occurs, it would probably be a very unfortunate day for public companies and for investors as well. Unreliable financial statements have an adverse impact on the market’s efficiency and on the public’s trust in the market. Liquidity will also be affected, as will be the companies’ (already unremarkable) incentive to raise capital from the public.

I will do everything necessary to ensure that that does not happen on my watch.

It is important for me to stress that the final responsibility for the accuracy of the financial statements ultimately lies with the board of directors.

The board of directors has the final responsibility for the integrity and accuracy of the financial statements, and approves them before they are made public. That is why the directors — including the external directors who are undoubtedly gatekeepers of the first order — must ensure that they have true, reliable, and complete information about the financial statements before they approve them.

To optimally fulfill this role, the directors must ensure that the information flows to them is reliable, complete, and of high quality. The directors are required to verify that they obtain the information that is required to be sent to them by law, so as to ensure that the company’s position is consistent with its financial statements. A board of directors who makes decisions without this information, or a board whose access to information is restricted, or does not take steps to ensure that it receives missing information — is not doing its job properly.

I would like to share with you that I recently received inquiries from directors who asked that we clarify whether a director may make a direct request, not through the CEO, for information about the company’s position. I would like to use this opportunity to clarify that directors have a responsibility to familiarize themselves with the company’s business, and must demand and obtain the information that they are entitled to receive. If the CEO fails to furnish such information, the director may make a request to any other function as he or she deems fit. If, after all those efforts, the director believes that he lacks the tools to perform his duties in a proper manner, he can use all the means at his disposal, including submission of a letter of resignation including a demand that the company make the resignation letter public.

I am confident that for some people this might entail a heavy personal toll, but I believe that the price exacted is much higher when a director becomes blind to the circumstances and conducts herself in a routine manner even when she feels that she lacks the tools to act with confidence and certainty in serving the interests of the company and the public. It is not enough for a director to argue that she was never privy to this or that piece of information. The key question is whether she did everything in her ability to obtain that information.

This also applies to members of the company’s audit committee and especially the members of the balance sheet committee whose position requires that they thoroughly study and critically review the financial statements, and pose questions to understand the company’s business operations and how they are presented in the financial statements, understand the risks and ensure that the appropriate internal controls are in place, and wave a red flag signaling danger when necessary.

So without deciding the exact degree to which the CFO constitutes a gatekeeper, let us summarize that the CFO is undoubtedly a significant function whose powers and responsibility can prevent serious damage to the investor public. This is what the law determines, and this is the expectation that I and the ISA have of all of you.

A final word concerning your roles as CFOs in the present and the future, which are tightly bound to our present and future roles as regulators.

The CFO function has undergone a revolution in the past decade, with many new areas of responsibility being added to this function, whose scope was much more limited in the past.

Today, many CFOs are leaders of organizational change in their respective companies. Their close knowledge of all the company’s financial and business operations, the risks that the company faces and addresses, and the members of the management team, has turned them into a key factor in all major company decisions. This is especially the case when a company experiences challenges that call for significant changes and difficult decisions, and sometimes require a very rapid response.

The CFOs of today not only prepare excel spreadsheets, to a large extent they are also involved in transforming these spreadsheets into the company’s business reality.

What is the outlook for the future?

A global survey conducted by KPMG two years ago among 500 CEOs indicated that more than two thirds of respondents believed that the position of CFO will expand significantly more than other managerial positions in the future; that global experience is the most important attribute for a CFO; that the regulatory environment is the external factor with the strongest influence on the CFO; and that CFOs must know how to use and apply technological tools, work with Big Data, and perform analyses of digital data.

I would like to share with you that in the ISA’s strategic plan for the coming years, we intend to promote smart regulation that protects investors without harming entrepreneurs; we intend to perfect our knowledge of the law operating in successful markets with the aim of promoting corresponding laws in Israel; and of course we intend to encourage the adoption of innovative technologies and their integration into the operations of regulated entities and in the ISA’s ongoing work and market development. By doing so, the ISA wishes to establish closer ties with the players in the market and foster trust between market players and technology suppliers in order to create a supportive, attracting environment that will facilitate the financing efforts of Israeli high-tech companies through the Israeli capital market. We are obligated to use all the means available to us to achieve this goal.

As I noted at the outset, we share many goals and challenges, first due to the fact that you are our direct clients, and second, due to our shared need for a healthy, strong, and developed market. Ultimately, you will also share the added value created by our efforts to develop the market and integrate new technologies in our ordinary activities and in the market as a whole.

Thank you.

[1] Civil Appeal 2506/09 Shlomo Zaig v. Kesselman and Kesselman Accountants – “The auditing accountants are part of an entire array of professional factors that are external to the corporation and are called “gatekeepers’ – which also includes analysts, rating companies, underwriters, and others – whose role is to protect the interests of the investor public through reliable information about the corporation’s financial position. The inference from securities laws to our matter indicates that the personal cause of action that a shareholder has against an account will exist when the shareholder sustained damage as a result of a misrepresentation in the auditing accountant’s opinion or in the financial statements that were audited and approved by it.”

[2] Class Action (Tel Aviv) 49602-11-11 Shlomo Fijo v. Michael Hirshberg – “Any factor that fills the role of a gatekeeper in such a company, whether he is an officer, director, or auditing accounting, should and is obligated to examine the financial data that he receives with utmost caution, and take active steps to prevent the risk that might stem from this conflict of interest.”

[3] Administrative Appeal 55314-07-15 Rozen and others v. Israel Securities Authority and others.  ​

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