Fall 2006 issue of Horizons

A P u b l i c a t i o n b y R u b i n B r o w n L L P

Value Planning for Your Business

INSIDE DISCOVER THE PATHS TO CREATING AND PROTECTING VALUE BUSINESS SCHOOLS AND CATT VALUE Page 24 SUCCESS BEHIND BARRY-WEHMILLER Page 27 AND MORE BUILDING BUSINESS AT HARBOUR GROUP Page 9 HOW BAKER TILLY ADDS VALUE Page 7 SIX MYTHS ABOUT FRAUD Page 13

horizons

CONTENTS

ii Welcome 1 RubinBrown Promotions

2 Upcoming Events 3 ASK RubinBrown 5 For Your Money 7 International News: Baker Tilly 9 Feature Article: Building Business at Harbour Group 11 Intangible Assets and Value Creation 13 Six Myths About Fraud 17 Implementing “SOX-like” Practices 19 Building Business Efficiency 22 Supporting Business Efficiency with Technology 24 Guest Article: James M. Daley, Dean of Helzberg School of Management at Rockhurst University 27 Client Spotlight: Barry-Wehmiller

INDUSTRY NEWS

31 ARCHITECTS & ENGINEERS 33 AUTOMOTIVE

35 CONTRACTORS 37 HEALTH CARE 39 HOME BUILDERS 41 HOSPITALITY 43 LAW FIRMS 45 MANUFACTURING & DISTRIBUTION 47 MORTGAGE BANKERS

49 NOT-FOR-PROFIT 53 PUBLIC SECTOR 56 REAL ESTATE

INFORMATION Editor: Eric Gutberlet Graphic Design: Millennium Communications Marketing Assistant: Laura Garanzini

Horizons, a publication of RubinBrown LLP, is designed to provide general information regarding the subject matters covered. Although prepared by professionals, its contents should not be construed as the rendering of advice regarding specific situations. If accounting, legal or other expert assistance is needed, consult with your professional business advisor. Please call RubinBrown with any questions. Located in St. Louis and Kansas City, RubinBrown has become one of the largest accounting and business consulting firms in the Midwest. www.rubinbrown.com

John Herber Managing Partner

Welcome

For business owners, managers and investors, the business climate is a very competitive environment. As business owners, we are challenged with making decisions on business initiatives that enhance and build value and in time pass on to succeeding generations. As managers, we look to create value through the processes and operations we manage to meet our projections. Finally, as investors, we look for visionary com- panies with a track record of success or those gems buried in unglam- orous and forgotten industries that are ready for a period of growth and expansion. In this issue, we try to define company value. Where do we look for it, how do we define it, what is the basis we use to identify opportunities for profit and continued business growth? We also want to look at various aspects of a business today and offer ideas of improving business value. I invite you to read this publication and offer us your feedback. Our goal is always to build value for our clients and friends. We hope to hear from you - john.herber@rubinbrown.com . Pleasant reading.

St. Louis office RubinBrown

One North Brentwood St. Louis, MO 63105

Kansas City office RubinBrown 9300 West 110 th St. Ste. 600 Overland Park, KS 66210

ii • summer 2006 issue

RubinBrown Promotions

Eric A. Janson, CPA, was promoted to partner in the Assurance Services and SEC practice groups. In his new position, Eric provides assurance serv- ices, SEC advisory services, and consults on technical accounting topics and SEC financial reporting issues. Eric joined RubinBrown in 1997 and is a member of the American Institute of

David Berg was promoted to manager in RubinBrown's Wealth Management Group. In his new position, David specializes in tax returns for high net worth individuals and investment partner- ships. David has seven years of accounting expe- rience and joined RubinBrown in December 2002 after working for Frank, Rimerman & Co. He holds Tim Farquhar was promoted to manager in RubinBrown's Corporate Finance and Forensic Services Group. In his new position, Tim conducts valuations of businesses, intellectual property rights, and varying ownership interests. Tim also assists in all facets of dispute resolution. Prior to joining RubinBrown in 2004, he worked with two

Certified Public Accountants and the Missouri Society of Certified Public Accountants, from which he received a Bronze Medal Award for obtaining the third highest CPA exam score in Missouri. He holds a bachelor's degree in accounting from Truman State University and is on the board of directors for the Gateway Council of Hostelling International.

a bachelor's degree in finance from Santa Clara University.

Christopher J. Langley, CPA, was promoted to partner in the Assurance Services and Real Estate Services groups. Prior to joining RubinBrown in 2002, Chris worked in the real estate and retail industries, where he served as the controller and assistant controller for two local real estate man- agement companies. At RubinBrown, Chris spe-

major corporations around the country. Tim graduated from Duke University with a bachelor's degree in comparative areas of study and Spanish and obtained his master's degree in business administration from Washington University in St. Louis. He is a member of the Chartered Financial Analysts Institute and the St. Louis Society of Financial Analysts.

cializes in audit, financial management and consulting services for multifamily, commercial and retail real estate clients. He holds a master's degree in business administration from Webster University and a bachelor's degree in business administration with a focus in accounting from Illinois College. Chris is a mem- ber of the American Institute of Certified Public Accountants and the Missouri Society of Certified Public Accountants.

Christina L. Jenkins, CPA, was promoted to manager in the Assurance Services Group. In her new position, she manages plan audits and assists in proposals for new plan audit engage- ments. Prior to joining RubinBrown in 2004, Christina worked for two national accounting firms in St. Louis. She graduated from Missouri

State University with a bachelor's degree in accounting and is a member of the American Institute of Certified Public Accountants and the Missouri Society of Certified Public Accountants.

Felicia M. Malter, CPA, was promoted to partner in the Assurance Services Group. She provides comprehensive audit and business consulting services to clients in the manufacturing, distribu- tion and home building industries. Felicia also has a strong business foundation that includes serving clients ranging from Fortune 500 publicly traded

Maureen M. Pardo, CPA, was promoted to man- ager in the Assurance Services Group. She specif- ically works with the real estate, home building and hospitality service groups. Maureen began at RubinBrown after obtaining a bachelor's degree in accounting from Truman State University in 2001. She currently is pursuing her master's degree in

corporations to private startup ventures. She joined RubinBrown in 2003 and holds a bachelor's degree in accounting from Indiana University. Felicia is a member of the American Institute of Certified Public Accountants and the Missouri Society of Certified Public Accountants.

business administration from Saint Louis University. A member of the Missouri Society of Certified Public Accountants, Maureen earned Missouri's fifth highest score on the May 2001 CPA exam and also holds positions with the Accounting Careers Committee and the Young Professional Advisory Council. She also is a 2006 Manchester Who's Who recipient.

James R. Ritts, CPA, was promoted to partner in the Tax Consulting Services Group. He works with clients in the contractors, manufacturing and dis- tribution, consulting and not-for-profit groups. Prior to joining RubinBrown in 2004, Jim worked for two national accounting firms. He is responsi- ble for assisting business clients in resolving fed-

Tracy L. Senf, CPA, was promoted to manager in the Assurance Services Group. In her new posi- tion, Tracy manages and supervises audit engagements for clients in the real estate and mortgage banking industries. Tracy joined RubinBrown in July 2000 after she graduated from Maryville University with a master's degree in

eral income tax issues. Jim holds a bachelor's degree in business administration with a focus in accounting from the University of Missouri-St. Louis. He is a member of the American Institute of Certified Public Accountants and the Missouri Society of Certified Public Accountants. In addition, he volunteers with the St. Louis Boy Scouts of America, for which he is involved with the Friends of Scouting Campaign and serves as an assistant scoutmaster. Jim also is a member on the board of directors of Les Amis.

business administration and a bachelor's degree in accounting. She is a member of the American Institute of Certified Public Accountants, the Missouri Society of Certified Public Accountants, Commercial Real Estate Women and the Urban Land Institute Young Leaders.

1 • summer 2006 issue

Upcoming Events

• Cornerstone Series Wednesday, October 18, 2006

• Financial Executive Series Thursday, December 7, 2006

• Cornerstone Series Wednesday, December 13, 2006

2 • summer 2006 issue

INDUSTRY PUBLIC SECTOR Deposit and Investment Risks ASK Rubi Brown

What is the Impact of the New Auditing Standards?

Fred Kostecki, CPA

significant strengthening of auditing standards that will improve the quality and effectiveness of audits. The new standards require a risk-based approach to the financial statement audit that entails: 1. A more in-depth understanding of the entity and its environment, including its internal control. This knowledge will be used to identify the risk of material misstatement in the financial statements and what the entity is doing to mitigate that risk. 3. Improved linkage between the assessed risks and the nature, timing and extent of audit procedures performed in response to those risks. Your auditors at RubinBrown are working hard to fully understand these new standards and to develop an approach to applying these requirements in a manner that is efficient, yet results in a financial statement audit of the highest quality. At RubinBrown, our mission is to help our clients build and protect value while at all times honoring our responsibility to serve the public interest. Not only will we fully comply with the new standards, we also will strive to continue to enhance the quality of our audits and to pro- vide value to our clients and all stakeholders. 2. A more rigorous risk assessment of material financial statement misstatement based on that understanding.

Complex and costly rules mandated for public company audits continue to trickle down to audits of non-public entities. As auditors, we work in a new world where regulators and the public are demanding more of the financial statement audit than ever before. The Sarbanes-Oxley Act of 2002 revamped the way audits are performed for public companies. The American Institute of Certified Public Accountants responded with Statement on Auditing Standards (SAS) No. 99, which required auditors of all entities, including those that are privately held, to identify and assess risks of fraud that could result in materially misstated financial state- ments. Now, the AICPA has issued 10 new auditing stan- dards that will significantly increase the effort required by auditors to complete a financial statement audit. Two of the new standards requiring significantly increased audit documentation and written communication regarding internal control related matters will take effect for 2006 audits, while the remaining eight new standards will apply to 2007 audits. These eight new standards will essentially require a new audit approach for all financial statement audits. The AICPA believes the new standards represent a

3 • summer 2006 issue

N EW A UDITING S TANDARDS P ROMULGATED BY THE AICPA

SAS No. 103 - Audit Documentation

SAS No. 104 - Due Professional Care in the Performance of Work

SAS No. 105 - Generally Accepted Auditing Standards

SAS No. 106 - Audit Evidence

SAS No. 107 - Audit Risk and Materiality in Conducting an Audit

SAS No. 108 - Planning and Supervision

SAS No. 109 - Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement

SAS No. 110 - Performing Audit Procedures in Response to Assessed Risks and Evaluating the Audit Evidence Obtained

SAS No. 111 - Audit Sampling

SAS No. 112 - Communicating Internal Control Related Matters Identified in an Audit

Questions? Contact Fred Kostecki, CPA Partner-in-Charge, Assurance Services Group 314-290-3398 fred.kostecki@rubinbrown.com

4 • summer 2006 issue

INDUSTRY PUBLIC SECTOR Deposit and Investment Risks For Your Money

Hedge Funds: What, Why, How and Considerations

Mike Ferman, CPA

In the past few years, the interest in “hedge funds” has grown considerably. However, the level of understanding about what hedge funds are, why investors use them, how they work, and the issues an investor should consider before investing varies greatly. Therefore, I would like to cover some of the basics in this article to help you gain a better understanding of this pop- ular investment product. The Securities and Exchange Commission defines hedge funds as “a pool of investors' money that invests in financial instruments in an effort to make a positive return. Many hedge funds seek to profit in all kinds of markets by pursuing lever- aging and other speculative investment practices that may increase the risk of investment loss.” The term hedge fund is a bit misleading in that a hedge fund does not have to hedge - that is, engage in risk reduction strategies. Instead, the term hedge fund now means any type of private investment part- nership. Hedge funds are similar to mutual funds in that they pool investors' money and invest it collectively. However, hedge funds differ significantly from mutual funds because hedge funds are not required to register under the Federal Securities laws. They are not required to register because they general- ly accept as partners financially sophisticated investors (“accredited”) and large institutions, and they do not publicly offer their partnership interests.

requiring a certain degree of liquidity, that partnership units be redeemable at any time, avoidance of conflicts of interest, fairness of pricing of fund units, disclosure regulations, limits and the use of leverage, and diversification. Hedge funds are, however, subject to the antifraud provisions of the Securities laws, but they are not directly subject to examination by the Securities and Exchange Commission. Hedge funds, unlike mutual funds, do not have boards of direc- tors or have to report their results in a standardized format. Hedge funds also pay both an asset-based fee (typically 1 or 2 percent of assets) and a performance fee that is typically 20 percent or more of the hedge fund's annual profits (realized or not), but often may be paid only if the hedge fund's performance exceeds a benchmark set forth in the fund's offer- ing documents. The allure of hedge funds lies in that they typically seek absolute returns rather than relative returns. What does this mean? Most mutual funds invest in a predetermined style, e.g., “small cap value” or in a particular sector. The fund's goal is to outperform its style benchmark or peer group. This return is rel- ative to its benchmark, peer group or index. If your fund is down 7 percent and its index or benchmark is down 10 percent, the fund is considered a success. Hedge funds, on the other hand, seek absolute positive returns regardless of what an index or sector benchmark does. Unlike mutual funds, which are “long only” (make buy and sell decisions only), a hedge fund engages in more aggressive strategies and positions, such as short selling, trading in derivative instruments like options and forward contracts, and using leverage.

Accordingly, hedge funds are subject to few regulatory con- trols. Such controls, if required, might include, among others,

5 • summer 2006 issue

Therefore, theoretically speaking, a hedge fund should outperform a mutual fund in a bear market because of these short positions and hedges and underperform in a bull market. However, as I mentioned earlier, a hedge fund can invest in anything and its strategy may not be as described above. Also, since different hedge funds may employ different strategies, consider diversifying your investment in hedge funds into several different ones to mitigate risk in case one strategy is not in favor. Some of the broad categories of hedge funds you may find are arbitrage strategies, event-driven strategies and directional or tactical strategies. Each of these has many sub-strategies, all with different risk and return characteristics.

Do your homework before investing in a hedge fund! Do not just rely on what the salesperson tells you. Quite often they are as much in the dark about what the hedge fund does as you are due to the lack of disclosure requirements. At a minimum, consider the following: 1. Read the offering memorandum. 2. Understand how the fund's assets are valued. 3. Ask questions about fees. 4. Understand any limitations on your right to redeem your shares or partnership units. 5. Research the background of the managers. 6. Be sure you understand the level of risk in the fund's strategy. More return generally means more risk. 7. Talk to your tax advisor. Hedge funds issue complex Form K-1s that may require extension of your return, added tax return preparation costs, and additional reporting requirements.

Questions? Contact Mike Ferman, CPA Managing Director, RubinBrown Advisors 314-290-3211 mike.ferman@rubinbrown.com

RubinBrown Advisors may only transact business in any state if we are first registered, excluded or exempted from the applicable registration requirements. Follow-up, individual responses or rendering of personalized investment advice for compensation will not be made absent compliance with applicable state registration requirements or an applicable exemption or exclusion.

6 • summer 2006 issue

INDUSTRY PUBLIC SECTOR Deposit and Investment Risks Interna io al New

Baker Tilly International Adds Value

Jim Castellano, CPA

Our international network, Baker Tilly International, Ltd. (Baker Tilly), is thriving and continuing to provide value to our clients doing business around the world. Baker Tilly is a global network of independent accounting firms. All international accounting firms are networks like Baker Tilly, operating separate

entities in various countries and regions around the world. Today, Baker Tilly ranks

as the eighth largest accounting firm network in the world.

7 • summer 2006 issue

Our Baker Tilly firm in China boasts nearly 1,500 staff in 18 offices. Other countries covered by our network in the Asia Pacific Region include India, Japan, Korea, Taiwan, Singapore, Thailand, Australia and New Zealand, to name just a few. Our coverage throughout Europe is most impressive, with coverage in all countries of the European Union as well as many of the emerging economies of the former Soviet Union. The Europe, Middle East and Africa Region is composed of outstanding firms in all major economic centers. Of course, the North and South American Regions cover the U.S., Canada and Mexico, as well as Central and South America. Regional conferences conducted in 2006 in Bangkok, West Palm Beach and Istanbul have featured prominent speakers covering topics of significant importance to enable our firms to add value to their client relationships. The Alternative Investment Market (AIM) in London has been a subject of great interest covered at these con- ferences. AIM is a second market of the London Stock Exchange, supporting capital-raising activities of early stage companies in their initial growth periods. More than 1,400 com- panies are now listed on the AIM exchange, with average market capitalization of approximately $80 million. Baker Tilly in London has been recognized as the AIM accounting firm of the year for three straight years. Baker Tilly firms have been leaders in the internal audit- ing profession. Baker Tilly International was a featured exhibitor at the annual conference of the Institute of Internal Auditors in Houston in June. Our exhibit at this conference, attended by more than 2,000 participants, showcased the depth of talent and broad intellectual capabilities of the internal audit practices of Baker Tilly firms.

Finally, three RubinBrown professionals are gaining international accounting experience this year by participating in the Baker Tilly international secondment program: Christine Kahle worked in London, Jeffrey

Sparks in New Zealand, and Chester Moyer in Australia. Likewise, expe- rienced profes- sionals from Baker Tilly firms

Moyer Kahle Sparks

outside the U.S. will be joining RubinBrown to gain exposure to the accounting profession in our country.

I invite you to visit the Baker Tilly International, Ltd. web site (www.bakertillyinternational.com) and the Baker Tilly International page on our web site (www.rubin- brown.com) for more information, and call me if you would like to know more about how RubinBrown can add value as you explore business opportunities glob- ally. Questions? Contact Jim Castellano, CPA Chairman, RubinBrown LLP, and Chairman of the International Board of Directors of Baker Tilly International, Ltd. 314-290-3300 jim.castellano@rubinbrown.com Baker Tilly International is a worldwide network of independent accounting firms with members throughout the world. It does not offer professional services in its own name. Each independent member of Baker Tilly International is a separate firm. These firms are not members of one international partnership or otherwise legal partners with each other, nor is any one firm responsible for the services or activities of any other. Although some firms carry the Baker Tilly name, there is no common ownership among the firms or by Baker Tilly International. Baker Tilly International, Ltd. is represented by 128 independent member firms in 85 countries. International Accounting Bulletin listed Baker Tilly International, Ltd. as the eighth largest network in the world as of December 2005.

8 • summer 2006 issue

FEATURE ARTICLE Harbour Group Builds Business

By Sam Fox

At Harbour Group, we have a passion for one thing - building businesses. Since 1976 we have focused on identifying potential value and building on it. Because of the quality of both our acquisitions and our management team, we have been successful in acquiring and building almost 150 companies.

But even more importantly, I believe we are creating enduring value – not only for ourselves, but also for employees, vendor partners and customers. We believe in making companies smarter, more competitive, finer. Our overriding objective is to substantially improve all of the businesses we own. After all, the future is where long-term value will be found. Whether businesses make consumer products or industrial products, we approach all of our companies with an eye toward building value. Companies may be operating in a high growth sector or a mature industry, but the rules are much the same. We look for market-leading companies with tremendous potential. Then we seek out complementary companies that will help build our market and thus create value. If that sounds formulaic, don't be fooled. Building value in businesses requires much more than a cookie-cutter approach to problem solving. Everyone involved must remain flexible, striving for successful solutions that meet everyone's needs. It's about creating win-win strategies for everyone. Sam Fox

We look for product-oriented businesses with a diverse customer base - market leaders with a clear competitive advantage. It is ideal if a company, along with any complementary businesses we may acquire, has a strong foothold in a sector with great potential for building market share and volume. We look for companies with a clear and sustainable competitive advantage because of one or more of the following: brands, proprietary products, services and unique customer relationships. If the company is operating in a fragmented industry, even more value can be created because of additional acquisition opportunities and our ability to marry product lines, people and services. We develop new strategies, drive new product development and improve operational processes and efficiency. This often means strengthening and expanding distribution. It almost always means invest- ing hard dollars in growth.

9 • summer 2006 issue

At the core of everything we do is an insistence on integrity, which we believe is an absolute business imperative. Without integrity, businesses will not prosper for the long term. That means being absolutely straightforward and can- did with managers, employees, vendors and customers – and, hopefully, vice versa. Whether dealing with a large or small business, we believe that the “devil is in the details.” That's why we've developed a methodology that looks at all the aspects of a business to assess its strengths and weaknesses. Performing rigorous due diligence and really understanding both the opportunities and challenges facing the business are critical steps. Without the facts, you are essentially run- ning “blind.”

approach is to work as smart and as hard as we can – for as long as it takes. The job needs to be done right.

Above all, it always gets back to integrity, integri- ty, integrity. That requires a high degree of frank- ness and candor. It also means that everyone involved must follow through on his or her com- mitments no matter how difficult it becomes. As Thomas Jefferson wrote in his June 15, 1792 letter to his cousin, John Garland Jefferson, “I am sure that in estimating every man's value either in private or public life, a pure integrity is the quality we take first into calculation, and that learning and talents are only the second.” Sam Fox is founder, Chairman and Chief Executive Officer of Harbour Group, Ltd., a privately owned operating company specializing in the acquisition and development of manufacturing companies. Among Fox's many awards are the Washington University Eliot Society Search Award, Horatio Alger Award, American Liver Foundation Missouri Chapter Leadership Award and St. Louis Citizen of the Year. Fox also is involved in numerous boards, including Washington University, Boy Scouts of America, the Saint Louis Art Museum and United Way of Greater St. Louis, among others. In addition, he founded and chairs the Fox Family Foundation. A veteran of the U.S. Navy, Fox holds a bachelor's degree from Washington University.

And when we acquire a company, we add the necessary resources to help operations drive internal growth and per-

formance and support the acquisition team as it searches for complementa- ry businesses. Comprehensive no-holds- barred operational reviews and evaluations are absolutely key. We identify weak points, remove redun- dancy, eliminate roadblocks to optimal productivity, and invest in new technologies, equipment and people where indicated. An easy trap is to fall victim to someone else's calendar. We work with a sense of

absolute urgency. However, we do not impede long-term results at the cost of adhering to a rigid timetable. Our

10 • summer 2006 issue

Intangible Assets and Value Creation

Dale Lash, CFA

One of the characteristics of successful companies that con- tinue to create shareholder value over time is strong and growing cash flow. But what drives the cash flow that builds value? One key component is intangible assets. It's widely accepted that intangible assets are the driver of value creation in the 21st century. In some industries, and among the market leaders, intangible assets can account for 90 percent or more of the total value of a company. Intangible assets include things like the trade name, cus- tomer lists, assembled workforce, patented technology and trade secrets. Although they typically are not listed on the bal- ance sheet, these assets are key contributors to the value of successful companies. They drive cash flow and value, because they provide their owners with competitive strength and benefits the competition cannot access. These benefits could be a long-standing customer relationship that enables the company to understand and serve the customer far better than the competition can. It also could be the benefit of

a strong brand presence in the marketplace or access to patented technology. Whatever it is, it creates value by providing real benefits - lower costs or higher revenues. Consider the total value of the intangible assets of your com- pany. Very simply, the value of your company's intangible assets is the difference between the total value of your com- pany and the value of the tangible assets. When you consid- er intangible assets from that perspective, there is a signifi- cant value that should be managed and enhanced. For many companies, focusing on tangible assets is a natural act with immediate results. Upgrading machinery at a manufacturing plant, for example, will provide immediate improvement in performance, adding value through greater efficiency, reduced costs and increased cash flows over time. Operational improvements such as these are easily under- stood, and the benefits derived from them are easily quanti- fied. More difficult to quantify, but no less important, are the benefits provided by upgrades in the intangible assets of an

11 • summer 2006 issue

TOP SECRET

organization. Such upgrades can add significant value, but the value might not be immediately recognized. However, the benefits of improved intangible assets will be felt over time, and the increased value of a firm's intangible assets certainly will be realized at the time the firm is sold. Additionally, many times a company will find that an increased focus on enhancing the value of its intangible assets will provide operational benefits as well. For instance, customer lists are intangible assets that can be great sources of value both to the firm and to a potential acquirer of the firm. The information normally retained in customer lists can provide essential and unique insight into those customers. Enhancing and expanding that insight can provide value to the firm from an operational standpoint and in the event of a sale. Assembled workforce: If relevant, consider extensive training to enable employees to reach a higher level of expertise. In the short run, enhanced employee expertise will improve the operational capabilities of the firm. Over the long term, a well-trained workforce could attract a potential acquirer seeking to expand into your industry but hesitant to spend the time and money to hire and train employees to reach the same level of expertise as your workforce. Extensive training also can help a company develop management depth and avoid key staffing issues. Having a strong top executive is great, but making sure that the business could survive without the top executive is essential. Customer Lists: When considering strategic options for the management of customer lists, it is important to remember that value is created in part through increased depth and breadth of a company's customer lists. That is, the amount of customer information a company retains is essential, but the Here are a few ideas on specific strategies to enhance intan- gible asset value:

size and diversity of a company's customer base is equally important. It's great to have a strong customer relationship that has enabled your company to grow rapidly, but too much customer concentration increases risk. Diversity is good, across industries if possible. Setting a diversified customer base as a strategic goal is a management decision that will reduce business risk for a company and make the company a more attractive acquisition target. Trade name: Think about potential acquisitions that would provide complementary products or capabilities that could be leveraged under your brand. For many companies, the culti- vation and maintenance of a strong brand can do more to create value than any physical asset. Because they are an important component of total firm value and because they will become even more important in the future, intangible assets should be considered as part of the total asset base. As such, they deserve as much of a compa- ny's attention as physical assets. In the years to come, compa- nies that focus on the management and enhancement of intangible assets will be rewarded with improved operational performance and increased shareholder value. Questions? Contact Dale Lash, CFA Partner, Corporate Finance & Forensic Services Group 314-290-3261 dale.lash@rubinbrown.com

12 • summer 2006 issue

Six Myths About Fraud

Organizations are more aware than ever about fraud and its consequences. However, 5 percent, or $650 billion, of corporate revenue is still lost to fraud each year. Following are six common misconceptions about fraud that continue to persist and, if not addressed, may leave your organization vulnerable to fraud.

Tom Zetlmeisl, CPA

Christina Solomon, CPA

Myth 1 “Our employees would not commit fraud.”

Fact: Even your most trusted employees may feel immense pressure to commit acts they never would consider under normal circumstances.

Myth 2 “One instance of fraud would not cause significant damage.”

Fact: It is easy to discount the impact one person's actions can have on your organization; however, the initial fraud and resulting “ripple effect” can be substantial. Almost two-thirds of fraudulent incidents are committed by a single person within an organization. Most people who start committing fraud will continue until the scheme is uncovered. What begins as a theft of an inconsequential amount can grow to hundreds of thousands of dollars in a short period of time. The median loss from occupational fraud is approximately $159,000, with one in three costing at least $500,000. If that isn't enough, the ripple effect may have a greater financial impact than the fraud itself. It is an expensive and time-con- suming task to uncover and attempt to quantify your losses as a result of fraud. It has been estimated that 40 percent of organizations do not recover any of their fraud losses. Those organizations that do, often recover less than one-fourth of the initial loss. Relying on insurance is not always sufficient, and fraud claims often lead to higher premiums. Furthermore, there may be irreparable harm to your organi- zation's reputation, and it may place your organization under undue financial strain.

Personal addictions, extravagant lifestyles, mounting medical bills or credit card debt could push an employee to commit

illegal acts. Employees with the incentive to commit fraud may do so if they can rationalize their actions and if they perceive they have the opportunity to get away with it. More than 80 percent of fraud perpetrators are classified as “employ- ees” or “managers.” The

median losses are approximately $78,000 and $218,000 per scheme for employees and managers, respectively. Frauds committed by members of an organization's key executives and owners are reported less often but can be more financial- ly devastating for your organization, with a median loss of $1 million per incident. In addition, there is a direct correlation between the length of time a perpetrator has been employed at an organization and the size of the fraud scheme. Tenured employees often have garnered the necessary trust from superiors and co-workers to commit and conceal fraudulent activities. Therefore, as we reward our employees with more authority and autonomy, we may also be unwittingly increasing their opportunity to com- mit extensive and financially significant fraud.

Myth 3 “We rely on our internal controls to detect fraud.”

Fact : Internal controls have inherent limitations.

Strong internal controls can have a significant impact on deterring fraud, and a well-designed control structure should

13 • summer 2006 issue

be a priority in any comprehensive anti-fraud program. Organizations generally have implemented better internal controls in recent years and may rely on them to detect fraud. However, the number one method of detecting fraud is an anonymous tip, accounting for more than 30 percent of reported cases. Internal controls ranked fourth, behind fraud detected by “accident.” Moreover, the internal control environment at your organiza- tion may not be aligned to address the fraud risks that mat- ter most. Often management focuses on cash theft, invento- ry and expense reimbursement schemes and fails to consid- er more invasive issues, such as financial statement fraud or computer crime, which may have a more significant impact on your organization. Although asset misappropriation is the most prevalent type of fraud, accounting for more than 90 percent of reported cases, it has relatively low median loss- es associated with it ($150,000). Financial statement fraud, on the other hand, is the least reported type of fraud but has the highest median loss at $2 million per incident. Finally, those responsible for monitoring internal controls often are not adequately trained or experienced to notice the fraud warning signs when present.

In addition to losses sustained from theft of cash receipts and cash on hand, companies suffer significant losses asso- ciated with fraudulent cash disbursements. Examples of fraudulent cash disbursements may range from check tam- pering to credit card return schemes to fictitious vendor or employee schemes. Your organization can be affected by each of these schemes regardless of its size. Although fraud within large, publicly held companies is wide- ly publicized, it is reported that private companies suffer the largest median losses from fraud. Further, smaller, privately held companies (those with 100 or fewer employees) suffer disproportionately large losses due to fraud compared to the largest organizations. It is harder for the smaller companies to survive the median loss of almost $200,000 per incident.

Myth 4 “Fraud couldn't happen to us - we're not like those companies you hear about.”

Fact: Fraud can occur in any organization regardless of its size, location or annual revenue.

Fraud does not necessarily involve complex schemes or col- lusion among members of your key management team. Often fraud is not even carefully concealed and may “fall apart” once the scheme grows too large or time consuming to cover up. By enforcing “mandatory vacations” for its employees, an organization may uncover or deter fraudulent activity.

14 • summer 2006 issue

Six Myths About Fraud

continued

Myth 5 “Between our external audits and/or Sarbanes-Oxley (SOX) compliance, fraud is adequately addressed in our organization.” Fact: Neither financial statement audits nor SOX compli- ance are a substitute for active risk assessment and monitoring the ongoing effectiveness of fraud deter- rence programs. External audits are the most commonly reported anti-fraud measure, ahead of internal audits and anonymous reporting mechanisms. However, external audits are cited as the detection method in only 12 percent of reported fraud cases. Internal audits have a greater impact on mitigating fraud loss- es than external audits alone. Internal audits are the third highest reported method for detecting fraud and are reported as the initial fraud detection mechanism in approximately 20 percent of reported cases. Companies with anonymous reporting mechanisms show half the losses due to fraud compared to those that do not. It is troubling to note that even though tips are reported to be the most effective method of detecting fraud, less than one- half of organizations have hotlines. SOX compliance includes elements of an anti-fraud program but primarily focuses on the risk assessment process, estab- lishing a code of ethics and whistle blower programs. Implementing these controls and anti-fraud programs help in establishing the proper “tone at the top,” but it remains unclear what impact SOX has on detecting and preventing corporate fraud of the sort that caused the collapse of Enron and WorldCom.

Myth 6: “Our aggressive stance of prosecuting fraud is our best protection.”

Fact: A zero-tolerance policy is important, but companies must recognize it does not always provide absolute fraud protection. Employees who feel pressure to commit fraud likely will do so if they can rationalize their actions and if they perceive they have the opportunity to get away with it. One employee may be dissuaded from committing fraud if he/she has witnessed the consequences another perpetrator faced. Another employee, however, may just believe that per- son was not resourceful or clever enough not to get caught - and may have even learned a few ways to conceal his own fraud along the way.

15 • summer 2006 issue

Addressing Fraud in Your Organization

Do not be complacent when it comes to fraud. Take action. View fraud from a number of perspectives when evaluating the fraud risk factors in your organization and developing and monitoring deterrence programs. After all, the most cost-effective way to combat fraud is to prevent it. Once it occurs, it is expensive and time consuming to recover, and often these efforts do not prove successful. The statistics cited in this article are from the 2006 ACFE (Association of Certified Fraud Examiners) Report to the Nation on Occupational Fraud and Abuse. To find out more about the ACFE or to obtain a copy of the 2006 Report to the Nation, visit www.acfe.com or contact RubinBrown for more information. Questions? Contact Christina Solomon, CPA Manager, Corporate Finance & Forensic Services Group 314-290-3497 christina.solomon@rubinbrown.com or Tom Zetlmeisl, CPA Manager, Corporate Finance & Forensic Services Group 314-290-3395 thomas.zetlmeisl@rubinbrown.com

16 • summer 2006 issue

Implementing “SOX-like” Practices

CORPORATE GOVERNANCE One of the benefits of SOX is the attention it has brought to the concept of corporate governance. Board members are more actively engaged in the oversight of the organization and are involved in the overall strategy, culture and expecta- tion of how the business should be run. Corporate gover- nance begins at the top, with the board and senior manage- ment, but eventually needs to be embedded in an organiza- tion and involve staff at all levels. An effective corporate governance program creates an environment of vision, trust, values and accountability. What organization would not want to embrace and embody such concepts throughout its organization? Although the phrase corporate governance sounds esoteric, implementing some- thing that makes sense can be quite simple. To begin, there must be commitment from the board and senior management - a commitment to embrace the concept and implement it across the organization. A practical approach that has worked in the Sarbanes-Oxley environment is to adopt a set of policies and procedures that communicate the expectations of the board and senior management. Corporate Governance Activity - Items to Consider Establish a Board of Directors and Appropriate Committees • Has the company established a board of directors? • Does the company have appropriate board committees, such as a compensation and audit/finance committee? • Are board and committee roles and responsibilities clearly defined? Establish a Strategic Business Plan • Has management developed a long-range plan for the company? It has been four years since the passage of the Sarbanes-Oxley Act of 2002 (SOX) and there are still questions looming as to the cost/benefit of comply- ing with the law. The Act applies specifically to publicly traded companies. While management of private businesses and not-for-profit institutions are happy they do not have to comply, they are being pressured by their boards to look for the benefits and best practices of SOX and consider implementing ”SOX-like” practices. What are these “SOX-like” practices? They fall primari- ly under two key areas - corporate governance and financial controls. They are good business practices for any organization - public or private, required or not. Following are some of the key measures/controls to consider in implementing an effective corporate governance program:

Steve Newstead, CPA, FLMI

Mike Ramirez, CPA

• Does the plan identify the financial and operational goals of the business? Establish a Corporate Code of Conduct • Do all employees sign a corporate code of conduct? How often? • Does it cover: - Outside employment? - Gifts to employees from vendors or suppliers? - Conflicts of interest? - Confidential information? - Misuse of firm property? - Copying of software, articles, etc? Establish an Annual Business Plan and Budget • Does the organization have an annual business plan and budget? • Is it used to monitor monthly progress on business plan goals and objectives? • Does management compare actual results to the budget and discuss variances with appropriate staff? Understand Enterprise Risk Management • Is there a group within the organization that manages enterprise risk, identifying ”what if” scenarios to ensure strategic, financial, operational and compliance objectives are met? • Has management and the board evaluated each identified risk and agreed upon a plan to mitigate the risk to an acceptable tolerance level? Establish a Hotline • Is there an independent hotline in place for employees to report financial irregularities and other apparent improper activities? • Is there a process in place to follow up on and report all hotline calls? Define Key Decision Strategies • Are policies established to limit the authority of manage- ment to contractually commit company resources? • Is the legal department reviewing all contracts?

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FINANCIAL CONTROLS

• Are there appropriate controls over the treasury function (i.e. authorization to open/close bank accounts, execute wire transfers, etc.)? Fixed Assets • Does the company have a capital versus expense accounting policy? • Is there a tracking and reporting system for disposals and transfers? Tax Accounting and Compliance • Has management identified its tax compliance require- ments (federal, state and local income taxes, property taxes, sales & use taxes, etc.)? • Are controls in place to ensure the accurate and timely fil- ing of returns? • Are personnel knowledgeable of tax accounting (FAS109)? Outsourced Activities/Functions • If the company is using a third party to provide accounting support, are controls and procedures over information submitted to and received from these providers adequate? This list of ”SOX-like” practices is not all-inclusive. It is based on our internal audit expertise and our experience assisting the manage- ment of more than 20 public companies with the implementation of SOX. Many companies are interested in implementing these con- trols to add value in the event of an acquisition or public offering. Or, it may reduce the cost of insurance if your underwriter is confi- dent in your corporate governance polices and practices. The bot- tom line, however, is that these are good business practices and controls that should be considered regardless of whether they are required by law. Questions? Contact Steve Newstead, CPA, FLMI Partner-in-Charge, Internal Audit Services Group 314-290-3325 steve.newstead@rubinbrown.com or Mike Ramirez, CPA Manager, Internal Audit Services Group 314-290-3455 mike.ramirez@rubinbrown.com These might include: - Payroll outsourcing - IT outsourcing - Benefits administration

Section 404 of SOX focuses on financial reporting. As a result, the quality and reliability of financial information pre- pared and reported by the accounting/finance department has improved. Having the CEO and CFO sign off on the financial statements and footnotes is key for all organiza- tions. Following is a list of some key financial internal con- trols that should be considered by companies that want to enhance their financial reporting activities and processes: Financial Control Activities - Items to Consider Revenue Recognition • What are the company's sources of revenue? • What controls are in place to ensure revenue is recorded in the correct accounting period? • Are monthly cut-off processes adequate? • Are nonstandard shipping and selling terms communicated? • What controls are in place over returns and credits? • Are sales contracts and side agreements communicated to and reviewed by accounting personnel? • Are warranties and related accruals established and are they adequate? Month-End Closing Checklist • Does each division have a standard reporting package that is prepared and sent to corporate accounting? • Does management use a checklist to ensure all month- end activities are completed (i.e. journal entries, reconcili- ations & analysis, etc.)? • Is there a monthly review and analysis of accruals, esti- mates and other judgmental accounts? Account Reconciliations • Are all significant accounts reconciled timely and reconciling items investigated and cleared? • Are all reconciliations reviewed by someone other than the preparer? Journal Entries • Are journal entries (recurring and non-standard) properly approved and supported? Cash/Funds Management • Is cash deposited and recorded on a timely basis? • Does the company use a lock-box? • Are there adequate controls over the approval of disburse- ments and signing of checks?

18 • summer 2006 issue

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