The 2002 U.S. Sarbanes-Oxley Act

Will it work and how does it affect Mexico?

By: Der Hurley MBA, CrFA, CFE

Most large corporations need the investing public to provide them with financing. Their shares are bought and sold in stock markets. The investing public will buy shares they think will bring the highest return. The value or price of a share is determined by how a company is doing at a given moment. Entities produce financial statements to inform the public how they are doing. Companies that offer their shares for sale to the public are mandated by law to hire an external auditing company to independently certify that their financial statements are true. U.S. stock exchanges are popular places for selling shares. Why? The U.S. is a wealthy country and one in every two U.S. adult citizen’s trade in stock markets. Most major multinationals of the world sell their shares in the U.S., including major Mexican based corporations. The U.S. share market is very competitive. There is tremendous pressure on companies to increase or at least maintain the price of their shares. They do this by putting their best face forward. People who are trying to sell themselves in an interview or on a date will dress or apply make-up to kill. So too can companies trying to sell their shares. The financial statements corporations produce to support their share price may range from the whole truth to a pack of downright lies. In the U.S. the regulatory body that oversees the public share market is the Securities and Exchange Commission or SEC for short. The SEC exists to oversee that all financial statements presented by share offerers to the U.S. public are not a bunch of lies. The 2002 Sarbanes-Oxley (SOX) Act extends the SEC’s regulatory powers. SOX was born out of a crisis just as the SEC itself was. The SEC was created soon after the Wall Street Crash of 1929. SOX was passed soon after the crashes of Enron, WorldCom and the external auditing company Arthur Andersen. Towards the end of the last decade some large U.S. based multinationals began to experience financial difficulties. Most rode the storm and reported the difficulties within their financial statements. A few decided differently, including Enron and WorldCom. Both companies produced false financial statements to cover up their financial woes. Enron and WorldCom deceived their outside auditors Arthur Andersen into thinking they were making profits when in fact they were losing money heavily. Once Enron and WorldCom got past their auditing gatekeepers they were able to deceive the SEC and the whole world. When the truth eventually came out, their share prices plummeted and both corporations went into bankruptcy. Arthur Andersen was barely recovering after Enron when WorldCom came along. WorldCom was Arthur Andersen’s deathblow and they too disappeared. Thousands lost their jobs. Millions lost their investments. The sheer scale of public outrage prompted the U.S. congress to introduce the SOX act.

Will SOX Work?

In the early 1930’s the SEC was created to protect the U.S. public from corporations and individuals that deliberately lie in order to attract investors. At that time the U.S. investing public cried out for a gatekeeper institution that would minimize the risk of their investing in fraudulent projects. The challenge for the SEC is that most investment projects that eventually turn fraudulent, start out honestly. The most notorious investment fraud scheme of all, the infamous Ponzi scheme, started life in good faith. Charles Ponzi was an impoverished Italian post World War 1 immigrant to the U.S. when he saw an opportunity that he genuinely thought was worth investing in. After the First World War, some European countries began issuing and selling postage stamps to finance reconstruction. Mr. Ponzi began buying and selling stamps. He initially turned a profit so he invited outside investors to participate. He promised huge short-term returns that he genuinely believed he could pay. The postage stamp business soon turned sour and Mr. Ponzi found himself in trouble. Rather than informing his investors that he could not meet his obligations he decided to pay them off. In order to get money to pay the initial investors Mr. Ponzi found more investors promising even higher returns. The new investors saw Mr. Ponzi paying huge dividends to the first investors so they thought they were onto a good thing. Many of the initial investors reinvested. Soon Mr. Ponzi forgot all about the postage stamps and concentrated all his efforts in persuading people to invest in nothing for huge returns. It went on and on, new investors paying off previous investors and also, of course, paying for Mr. Ponzi´s fabulous new lifestyle.

After the SEC was founded, two tools have been relied upon to achieve the objective of preventing people like Ponzi from soliciting investment funds from the U.S. public. The principal tool was that corporations were mandated to contract independent external auditors to verify whether or not their financial statements were true. A secondary tool was that the same corporations were required to send their quarterly and annual financial statements to the SEC. The system worked well. The U.S. economy grew by leaps and bounds. Most companies selling their shares through the U.S. stock markets were honest. Naturally they were exceptions. The SEC could not be expected to be 100% effective.

Then came Enron and WorldCom. The problem was not only the scale of the debacle. Another major issue was that Enron and WorldCom easily surmounted the principal SEC safeguard - independent assessment of the financial statements by the external auditors. There was a strong perception within U.S. public opinion that not only did Enron and WorldCom succeed in duping Arthur Andersen but they actually succeeded in co-opting the external auditors on board their fraudulent schemes. Forensic accountants and fraud examiners combed through Enron and WorldCom. They discovered the relationship both companies had with Arthur Andersen was altogether too cozy. The external auditing company was providing both Enron and WorldCom with all sorts of services that had nothing to do with the external audit. It was then perfectly legal for the external auditors to provide extra services to their clients. Something had to be done about this.

SOX attempts to address the ‘duping/co-opting’ issue through mandating external auditors to limit their services to each client to external auditing or other services but not both. Differently expressed, an external auditing company providing external audit services to a public corporation cannot provide other consulting services to the same client. Through this measure, SOX attempts to limit the commercial relationship between a publicly quoting corporation and its independent external auditors. It limits the commercial relationship but it does not avoid it. A corporation still has to pay an external auditing company to perform the audit. Some would argue that as long as the external auditors continue to have a commercial relationship with the company being audited they could never be truly independent.

Another issue highlighted by the Enron and WorldCom financial statement frauds was that their CEO’s cried ‘I did not know this was going on, I really thought our company was in great shape’. They tried to blame it all, at least initially, on lower-level employees. We all know what any good accountant is likely to say when asked what is two plus two - what would you like it to be is the half joking, half real reply! The moral of the story is that an accountant will declare that two plus two is equal to ten, only when requested to do so by the boss. SOX addresses the ‘no clue what was going on’ syndrome through mandating all CEO´s and CFO´s to sign-off on their quarterly and annual financial statements sent to the SEC. SOX mandates heavy jail time for signing off on falsified financial statements. However, there is no doubt that we will see in the future a CEO claiming the defense ‘I know I signed off on those financial statements but I was told by our financial people everything was okay.’

It is a commonly held belief that the financial statement fraud that occurred in Enron and WorldCom was due to weak internal controls. This is a myth. The internal controls over financial reporting in place in Enron and WorldCom were fine. What occurred at both companies is that top management overrode the internal controls. They put the internal controls to one side and went about their shenanigans. Fraud is more likely to occur in a company with weak internal controls. This statement is true for all frauds other than financial statement fraud. Internal controls over financial reporting will only function well in preventing financial statement fraud if allowed to by top management. The perpetrators of financial statement frauds are in a position to command their subordinates to ignore internal controls. SOX addresses the supposed weak internal control issue by mandating all publicly quoting companies to perform a yearly review of their internal controls over financial reporting. SOX further requires the external auditor’s certification of management’s review. Will this SOX measure be effective in preventing financial statement frauds in the future? As a forensic accountant and fraud examiner I am convinced that it will have little or no affect. I said above that occasionally corporations present financial statements that are a pack of lies. That is not quite true. What I should have said was - the final profit figure they come up with can be a huge lie. What occurred at Enron and WorldCom was that top management decided to manipulate a few accounts in order to come up with the final results they required. It was a bit like asking the accountants one hundred times what is two plus two. Ninety nine times out of the hundred they came up with four as the correct answer. Once in a hundred times they came up with ten as the false answer. Within Enron and WorldCom most of the financial reporting was done correctly. Consequently, the internal controls over financial reporting had to be functioning correctly. That little part of the financial reporting that was falsified and that had such enormous consequences was not a result of poor internal controls. It was a result of top management overriding the adequate internal controls in place in order to manipulate a limited number of accounting entries. With the internal control review mandate, SOX is trying to fix something that isn’t broken. The issue should not be the internal controls over financial reporting. The issue should be corporate governance and top management’s override of internal controls already in place. Apparently, there are thousands of public corporations currently spending millions of dollars in reviewing their internal controls over financial reporting. They are spending further enormous sums in paying their external auditors to review their review.

SOX does attempt to address the corporate governance issue through requiring the external auditors to report to the audit committee rather than top management. This sounds like the audit committee is being given some teeth at last. But who controls the audit committee’s budget? Will the CFO continue to control the cheques going out to the external auditors? In practice, the outside auditors will still have to deal mainly with the finance area for the day-to-day operation of the audit.

Another attempt to address the management override issue is the SOX mandate to all publicly quoting companies to allow their employees the opportunity to access a confidential fraud reporting mechanism. The SOX measure requires the confidential reporting mechanism, also known as a fraud hot-line, to be overseen by the audit committee and not top management. The thinking behind this measure is – would one or more of the lower-level employees at Enron and WorldCom have blown-the-whistle sooner if they had the opportunity? I am convinced they would have. Most accountants resent it when asked by their boss to declare two plus two is equal to ten. Many would jump at the opportunity to report the behaviour confidentially. The eventual whistle-blowers at WorldCom were their own internal auditors. Although they, like their external counterparts, are frequently seen as the enemy the internal auditors at WorldCom were tipped off by a lower-level financial employee. Studies conducted by the Association of Certified Fraud Examiners consistently show that fraud hot-lines are the most effective means of discovery of all types of fraud, not just financial statement fraud.

Under current corporate governance practice the chief internal auditor reports to the CFO or CEO. It was a miracle at WorldCom that the internal auditors eventually blew the whistle. The last decades have seen large corporations eliminating or downsizing their internal audit function. The U.S. investing public would have been well served if SOX mandated all public corporations to have an internal audit area. It would have been doubly well served if SOX mandated the head internal auditor to report directly to the chairperson of the audit committee. Then the internal auditors would be really looked upon as the enemy. Maybe after Enron, WorldCom and Arthur Andersen that would not be such a bad thing.

SOX FALLOUT IN MEXICO

SOX applies to all Mexican corporations that quote their shares in the U.S. or are subsidiaries of any corporation that quotes its shares in the U.S.

When SOX first appeared some non-U.S. based multinationals immediately cried foul. Many European commentators complained the U.S. was attempting to breach their sovereignty through the application of an extra-territorial law. It was quickly pointed out to European corporations if they wanted to enter the U.S. to look for financing they would have to abide by U.S. laws protecting that financing. The extra-territoriality issue has recently been brought to the fore in Mexico as a result of the SEC investigation into TV Azteca. Newspaper columnists have questioned the SEC´s right to investigate the Mexico City based conglomerate. The SEC´s reply is that TV Azteca quotes in the U.S. stock market. The SEC is actually not looking at the dealings of TV Azteca. Rather, it is looking at one deal carried out by TV Azteca’s president Ricardo Salinas. By questioning the deal, the SEC’s states it is looking after the interests of TV Azteca’s minority shareholders.

SOX mainly addresses financial statement fraud such as that occurred at Enron and WorldCom. However, the TV Azteca case does not involve financial statement fraud at all. It would be better described as a conflict-of-interest fraud. The key points of the case appear to be as follows:

TV Azteca owns some 45% of a telecommunications company called Unefon.

·- Unefon owed some U.S. $325M. to Canadian based communications equipment supplier Nortel.

·- Unefon claims to have financial difficulties and cannot pay Nortel.

·- Nortel finally agrees to accept U.S. $107M. to liquidate the debt.

·-A Unefon now claims it cannot pay the U.S. $107M.

·- TV Azteca president Ricardo Salinas and Unefon president Moises Saba form a U.S. corporation called Codisco.

·- Codisco pays Nortel U.S. $107M.

·- Unefon pays Codisco U.S. $325M. for services rendered.

·- Messrs. Salinas and Saba, apparently, make U.S. $109M. each on the deal.

No criminal charges have yet to be brought against anyone. The Mexican financial authority the Comisión Nacional Bancaria y Valores (CNBV) is currently investigating. The SEC alleges Mr. Salinas and Mr. Saba defrauded Unefon of some U.S. $218M. Many have asked in Mexico what business is that of the SEC’s? The SEC´s reply is that it is their business because TV Azteca is a 45% shareholder in Unefon and TV Azteca quotes in the U.S. stock market. The SEC claims that TV Azteca’s minority shareholders were damaged by the deal. The SEC has informed Mr. Salinas he has to pay damages to TV Azteca and a fine to the SEC. Otherwise, Mr. Salinas would be banned from executive office in any corporation that sells its shares in the U.S.

Salvatierra - Land of Lincoln

By: Der Hurley MBA, CrFA, CFE

January 2006

Immigrant remittances are a significant factor in Mexico’s economy. Last year immigrants sent some 20 billion dollars back to loved ones in Mexico. Figures for 2006 are expected to be around $25 billion. Remittances are now second only to oil exports and well ahead of tourism in foreign exchange earnings. Many families in the states of Zacatecas, Michoacan, Oaxaca and Guanajuato rely heavily on remittances sent by relatives living in the U.S.

They say there are more Guanajuatenses in the U.S. than there are in Mexico. The municipios surrounding Salvatierra in southern Guanajuato have the highest immigration records. It is a fertile area, rich in agriculture. Perhaps this explains the exodus. Agriculture, no matter how rich, seems to produce but not hold on to large populations. Salvatierra is a pleasant colonial city, not unlike San Miguel de Allende located to the north of Guanajuato state. It is ironic but there is U.S. immigration to Guanajuato. Foreigners are mainly located in and around San Miguel which has a population of about 90,000. Around 15,000 are mainly from the U.S. and Canada. Immigrants to Guanajuato make up in prestige what they lack in numbers. Antonio Banderas and Melanie Griffith keep a home near San Miguel. Perhaps it is not so ironic in this day and age of fast communications and fast travel that young Guanajuatenses go the U.S. to earn a living while older U.S. citizens retire to Guanajuato.

Salvatierra has some fine 16^th and 17^th century churches. There is a beautiful 17^th century bridge that’s still in use. The bridge leads to a park that overlooks waterfalls on the fast flowing Rio Lerma. However, you do not see many foreign travelers in Salvatierra. Tourists or no, Salvatierra is a busy place. What stands out is returning immigrants and their vehicles. Texas trucks and cars from Illinois. Lincoln’s face looks out from most U.S. number plates. Many of the vehicles with Guanajuato plates are legalized immigrant imports. I have heard many people speaking Spanish in New York, Los Angeles and Miami and found it perfectly normal but I was taken by surprise hearing young people conversing in English in Salvatierra. Probably kids of immigrants going home to see the grandparents - feeling more comfortable speaking English, the language they went to school in.

Vicente Fox is a Guanajuatense. He was governor of the state prior to his election as Mexico’s president. When he was governor he founded a state organization that aids Guanajuato immigrants. The Atención al Migrante office in Salvatierra is coordinated by Octavio García. Octavio tells me Salvatierra has a 30% immigration level. Some nearby municipios like Ocampo and Santiago Maravatio have levels of 50% plus. Octavio reckons 80% of all immigrants from Guanajuato are male. It used to be 100% male. More and more younger girls are now immigrating. This leads to a growing female exploitation problem along the Mexican side of the border. For the males the main objective is to support the wife and kids left behind. But time and distance sometimes skew that objective. The main focus of the Atención al Migrante office is to attend the relatives left behind rather than the immigrants themselves. A growing problem is household violence when men return. A much smaller but also growing problem is the HIV virus. Settled immigrants in Illinois can sometimes send their problem kids back to the grandparents for straightening out in Guanajuato. Octavio García perceives the reverse occurs - problem kids introduce gang violence and drug consumption to remote rural communities.

Most first time immigrants from south Guanajuato are illegal. An enganchador - a local facilitator and representative of the border coyote gangs, gathers a group of individuals together in a rural community. The Mexican immigration service, the Instituto Nacional de Migración, calls the people smugglers polleros - chicken runners. The group of about ten or twelve individuals will frequently be told to gather at a certain date at the bus station in Celaya or Queretaro where the enganchador will be waiting for them with their one-way tickets to Nogales, Ciudad Juarez or Reynosa. There, the border coyotes pick them up and take them to a local hotel. The total cost to cross illegally and get to their final destination varies from $2,000 to $3,000 dollars per person one way. A hefty price for a kid whose main reason for undertaking the hazardous journey is to earn money. However, illegals pay in stages. They will first pay for the ride from their hometown to Queretaro. Then pay the bus ticket Queretaro-Mexican border city. Then the hotel at the border town. More and more frequently the polleros decide to bus their groups to a smaller border town in the desert. This means further expense for the illegals in another hotel. Many illegals have to work their way across - most of the young first-timers will not have two to three thousand dollars to get them to Chicago or Atlanta.

Due to increased U.S. side border vigilance illegally crossing is becoming more and more expensive - and dangerous. The coyotes have to decide whether to take the safe route near population centers where the risk of getting caught is higher. Or take the desert route where the risk of at least some of their group losing their lives is greater. If the coyotes themselves get caught, they don’t get deported, they get jail. More and more they opt for the desert route. When crossing time comes and the illegals are faced with the enormity of the task before them, they have little choice but to move ahead as they are by now deep in debt to the coyotes. Octavio García, the Atención al Migrante coordinator in Salvatierra, reports what he perceives to be a disquieting trend. Illegal immigrant’s call his office from U.S. jails claiming they are serving time falsely accused of being coyotes. The story goes that the entire group is caught. The real coyote pretends to be just another illegal. He, frequently a good English speaker, ingratiates himself with the Border Patrol. He falsely accuses a non-English speaking illegal of being the coyote. The would-be illegal immigrant goes to jail. The coyote gets deported and lives to fight another day.

Everywhere you go in South Guanajuato you meet immigrants who have their fascinating story to tell. Like 22 year old Armando Montes who cleaned my sneakers in the Jardín of Salvatierra. Six years ago Armando made his first and last attempt to get in to the U.S. He crossed the Rio Bravo near Laredo along with nine others, including a coyote. Armando reckons the coyote was inexperienced. He allowed another one of the group to play his Walkman while crossing the river at night! They got to the other side okay and Armando began to relax a little. The then sixteen year-old allowed himself the luxury of thinking he might possibly succeed in getting as far as Atlanta. There his cousins had set-up a successful house painting business. Three days into the U.S. disaster struck. The Migra picked up eight of the group in San Antonio, including Armando and the inexperienced coyote. Armando was back in Mexico the following day. The Walkman player was one of the two who made it. I asked the would-be Atlanta house painter how much he charged for the shoeshine. Armando replied - whatever I thought was appropriate.

Vicente Zepeda left San Nicolas de Los Agostinos when he was twenty years old. San Nicolas is a rural community located close to Salvatierra. Vicente Zepeda immigrated to Moline, Illinois. It was tough at the beginning. He got the odd laboring job. After a while he got regular work and began sending money home to his parents. He saved enough to rent a shop selling Mexican food products. By now there was a huge Mexican population in Moline. They cried out for real tortillas, Mexican cheese, genuine sauces and a variety of chilies. Vicente now owns a chain of stores called La Imperial. In Guanajuato the governor initiated a program called Dos por Uno. For every peso an immigrant would put into a social program, the state government would invest a peso and the municipal government another peso. February 2005 Governor Romero inaugurated a badly needed health clinic in San Nicolas. Vicente Zepeda returned home for the first time in twenty eight years to be at the ceremony. He had contributed some $40,000 dollars towards the construction. The governor asked him to say a few words. Vicente went to the podium but no words came, only tears.

In 1550 the Augustinians built an awesome fortress-like church to dominate the local people around Yuriria. The magnificent monastery still dominates Yuriria to this day. The same Augustinians engineered a huge lake nearby. Strange bunch the conquistadors! They drained a beautiful natural lake in Tenochtitlan/Mexico City and they created a shabby, artificial one in Yuriria. Maybe it wasn’t back then but it’s pretty shabby today. Coca-Cola and Pepsi would be swamped if they organized a return of their plastic bottles. Neither the lake nor the church draws many tourists to Yuriria these days. Yuriria is better known for the travelers that leave.

Rafael Cisneros is known to all in Yuriria as Don Rafa. He looks older than he is. Don Rafa has been through some tough battles trying to make a living. He first entered the U.S. illegally when he was 18. Since then he has come and went many times. No coyotes for Don Rafa, he believes in doing things himself. He almost died after spending three freezing nights in the desert near Yuma, Arizona. The longest he held down a job was for four years as a maintenance man in a Chicago golf course. He earned twelve dollars an hour there. In one of his returns to Yuriria he married Doña Socorro. While in Yuriria he and Socorro worked a mobile taco stand. In 1985 Don Rafa availed of an amnesty and received a U.S. green card. He traveled to Alaska and worked processing fish at twenty five dollars an hour. Coming and going. Off to the U.S. for a few months, back to Mexico for a few months. Come 1990 his wife put the foot down. By now they had six children. Sink or swim, Don Rafa was back to Yuriria for good. They moved their tacos to a permanent location on the road out of Yuriria towards Morelia. Though roofless, it was a good spot. They began to bring in about five thousand pesos a day. Don Rafa bought a plot of land and built a house. About eight years later disaster and salvation came calling the same day. Disaster in the form of the local municipal authorities informing the road needed widening. The Cisneros would have to move on. Salvation came a few hours later while Rafa sat dejected at one of his open-air tables. An individual came to eat and told Don Rafa he had a big site for sale about a half-kilometer up the road. Don Rafa went to see it and immediately decided to mortgage his home for a bank loan. He moved the open-air kitchen, tables and chairs to the new place. The first day he brought in fifteen thousand pesos! When he lay down to sleep that night Don Rafa made two promises to himself. The first was that one day he would employ a hundred people. The second promise; he would never return to the U.S.

The next step was to put a roof over the tables. Then came the construction of a hundred and twenty table restaurant. Next a twenty-four bedroom hotel on two floors over the restaurant. Then the construction of a salon-de-fiestas behind the restaurant. Don Rafa is currently building another restaurant down by the lake. Right now he employs about 50 people, including his six kids. Don Rafa hired a professional accountant to administer the business as well as a professional restaurant manager. They need the accountant. When I checked out of the hotel I asked Doña Socorro for an invoice. She looked around a little embarrassed and whispered she did not know how to prepare one. She said the accountant was not in but she could give me the invoice block so I could prepare it myself!

Doña Socorro and her kids have vacationed many times in the U.S., mostly visiting relatives in Illinois. They tried to persuade Don Rafa his promise was no longer binding. Last year he vacationed in Cuba. The year before he went to Cancun. The year before that Puerto Vallarta. He plans to travel to Canada this year. Don Rafa is a man of his word; he intends to keep both promises he made to himself that fateful night.

Santiago Maravatio has the highest per capita immigration rate of all the municipios of Guanajuato. In spite of that, or perhaps because of it, there is an air of prosperity about the place. The fields surrounding the town all seem to have electric pumps providing water for irrigation. You see in and around Santiago Maravatio something rare in rural Mexico - tractors. Adolfo Sanchez left for Wheeling, Illinois when he was seventeen years old. Adolfo did okay for himself. He initially stayed with relatives and did part-time work. He soon got regular night-shift work at a Honeywell plant. He made enough money to rent his own apartment and buy a car. When he was twenty seven years old Adolfo got engaged. Jennifer Wiedemann was a twenty year old classical piano player and live-in nanny at the home of one of Adolfo Sanchez’s wealthy relatives in Wheeling. Adolfo visited his uncle’s place often. The couple got to know each other and decided to marry. But a few months later Jennifer called off the arrangement. She returned the engagement ring to Adolfo. He spent a couple of days trying to persuade her back. She was adamant. In the early hours of September 22, 2001 someone with a key entered the house where Jennifer worked, went down to the basement and shot her dead while she slept. A blood stained shotgun was found in Adolfo’s apartment and his abandoned car was found a few days later in Milwaukee. Local authorities believe Adolfo fled to Mexico.

María del Carmen Cardoso left Salvatierra when she was eighteen. Carmen is not her real name. She did not want her actual name published out of fear of getting booted out of the Phoenix university where she is currently studying law. She found a novel and safe way of entering the U.S. illegally. She traveled to Puerto Peñasco, Sonora where her aunt has a small hotel. Puerto Peñasco is located on the bridge of land connecting Baja California with Sonora, north of the Sea of Cortez. It is a beach resort little known in Mexico but well known in the U.S. state of Arizona. It used to be known as Punto Peñasco. Punto Peñasco´s English translation is Rocky Point. The beaches around Rocky Point are about a four hour drive from the two desert cities of Phoenix and Tucson. People from Phoenix go to Puerto Peñasco as frequently as people from Mexico City go to Acapulco. They are welcomed warmly by Puerto Peñascans despite sporadic outbreaks of trouble making, especially during Spring break. Many Arizonians have beach homes in the rapidly developing resort and many have immigrated there permanently. Puerto Peñasco´s population is about 100,000, around 8,000 of whom are U.S. immigrants. Carmen Cardoso found work cleaning the Puerto Peñasco beach home of a wealthy Arizona family. About a year later the parents asked her if she would like to become a nanny in their Phoenix home. Carmen jumped at the opportunity. One Monday morning she joined them in their minivan along with their three kids. There was a long line of RV’s going through the border crossing at Sonoyta, Sonora and Lukeville, Arizona. The border authorities on both sides just waved the family through.

Alternative Dispute Resolution

The Options for CEO´s and CFO´s

By: Der Hurley CrFA, CFE, MBA

Alternative Dispute Resolution (ADR) refers to any means of settling commercial disputes outside of the courtroom. The two most common forms of ADR are mediation and arbitration. Mediation and arbitration are alternatives to traditional litigation. Many company executives are attracted to mediation and arbitration due to a lack of confidence in the public civil litigation system. The perception among many executives is that civil court process is slow and expensive.

Executives comparing mediation vs. arbitration vs. litigation should keep in mind that traditional litigation judges are financed by the tax payer while mediators and arbitrators are paid for by the parties in dispute. The major problem associated with traditional litigation is not so much the cost but the time factor in coming to a final decision. Executives entering into litigation in good faith have little desire to face the long drawn out appeal scenarios. Also, as traditional litigation is financed out of public coffers, its content is publicly available information. Company executives rarely have any desire to see their dispute aired on television news programs. On the other hand, executives can be taken by surprise when informed they have no choice but to foot a hefty arbitration bill. To fully realize the cost benefit of ADR, CEO’s and CFO’s should be involved in the decision making process from the outset. This article addresses the financial implications of taking the ADR route and how to avoid excessive costs down the road.

Mediation

Mediation involves facilitating an agreement between disputing parties. Mediators are individuals who bring opposing parties together to negotiate a settlement between them. The parties in dispute are free to decide whether or not they accept their chosen mediator’s proposed agreement. Mediation’s principal attribute is that the process is speedy. Its principal defect is that it requires the goodwill of the parties in dispute to come to an agreement. Most commercial disputes involve money. If one of the parties to a dispute is unwilling or unable to come up with the money then they may use mediation to further prolong the dispute in order to buy time. A company executive will need to measure the risk of this occurring when approving an agreement to send a commercial dispute to mediation. If each party in dispute considers their adversary’s opposition is in good faith then mediation is very likely the optimum road to take.

Arbitration

Arbitration involves an independent arbitrator or a panel of three independent arbitrators gathering the commercial dispute evidence together and then deciding on an outcome to the dispute. It is like a trial but without the formal legal trappings. An arbitration decision is binding on the parties in dispute and is non-appealable. Therein lies its great attraction. It is not as speedy as mediation but it is much speedier than traditional litigation due to there being no recourse to appeal. The arbitration process is more expensive than mediation but it avoids mediation’s principal defect due to the compulsory nature of the arbitration judgment. The legal basis for arbitration is the agreement by the parties to undergo the process. That agreement allows for an impartial arbitration judgment to have the same binding legal force as a judicial sentence. If no such agreement exists there is no alternative to traditional litigation. If one of the parties can demonstrate that such an agreement exists then arbitration can go ahead even if the other party does not wish to participate. They have no choice legally due to their prior agreement to undergo the process. As in mediation, there is also the risk that one of the parties to an arbitration agreement is unable or unwilling to settle as instructed by the arbitrator and they may go through the process only to buy time. Their real intention may be to find legal loopholes in the procedure in order to later contest the arbitration decision in the courts. CEO´s and CFO´s need to address this risk from the outset if they wish to minimize costs. The worst case cost scenario would be a dispute where a company has to first foot a mediation bill, then an arbitration bill and then, to cap it all, a litigation bill.

What are the Costs of ADR?

Mediation costs include fees and expenses of the mediator, fees and expenses of any expert called by the mediator and agreed upon by the parties, expenses of any witnesses called by the mediator and agreed upon by the parties and facility expenses of the mediation provider if such facilities are used. The cost of arbitration will depend on whether the process is ad hoc or administered by an institution. An ad hoc arbitration is administered by independent arbitrators applying their preferred arbitration rules. The daily cost of an ad hoc arbitration will include the same concepts as mediation but the process frequently takes longer so its overall cost will be higher. The cost of an institutionally administered arbitration usually depends on the amount of money in dispute. The institution chosen by the disputing parties will charge an administration fee percentage plus an arbitrator’s fee percentage of the disputed amount.

Who pays the ADR bill? The bill is divided equally among the parties. An exception to this could occur when an arbitrator decides in a judgment that one of the parties is liable for costs. It may be stating the obvious that the ADR bill is divided equally among the parties but when taking a mediation vs. arbitration vs. litigation cost/benefit decision it should be kept in mind that traditional litigation is financed by the public taxpayer and not by the parties in dispute.

The major cost factor associated with arbitration will be the decision on having one or three arbitrators. Arbitration literature usually recommends three arbitrators if the issue in dispute is technically complicated. However, from a financial point of view a panel of three arbitrators will result in the cost of the arbitrator’s time being triplicated. A justification from a cost point of view for the three heads are better than one argument is when expert opinion is considered necessary within arbitration. The cost of outside expert opinion could be avoided if one of the arbitrators already is an expert. Another cost factor to be considered will be the language of the arbitration process. If the disputing parties decide that the process will be bilingual, the cost of translating witness testimony and documentary evidence should be taken into account. A third factor to be considered is the location of the arbitration proceedings. From a cost point of view the ideal location will be that which minimizes arbitration travel expense.

Ideal Arbitrators

The ideal arbitrator is a person who has integrity, is impartial when making a judgment decision, is totally independent of the parties in dispute and is a person who will maintain the confidentiality of the arbitration proceedings. Arbitrators are obligated to give a fair hearing to all sides in a dispute. Arbitrators are obliged to come to a fair decision even if one of the parties in dispute decides not to participate in the arbitration proceedings. If one of the parties decides not to participate though obliged to do so by prior agreement, the arbitrator must provide that party with sufficient notification of the proceedings. An arbitrator has to have a thorough knowledge of arbitration proceedings. Although devoid of legal formalities, arbitration does have its rules and regulations. An arbitrator has to apply the rules strictly in order to provide a balanced hearing to both sides and to ensure that the arbitration judgment will have the same binding legal force as a judicial sentence.

Arbitrators can come from any walk of life. The profession of the ideal arbitrator will depend on the issue in dispute. A party in dispute may go into arbitration looking for legal loopholes in order to buy time. If this is the case, the other party to the dispute may be well advised to seek a seasoned attorney as arbitrator. A dispute may involve complicated technical questions, within an information technology environment for example. In this case a systems engineer may be the best candidate. A civil engineer or arquitect may be called for as arbitrator within a construction dispute. All disputes finally involve money. If calculating value is the major issue, an accountant may be considered best arbitrator candidate. If the issue in dispute is considered to be legally, technically and financially complicated the optimum choice may be a panel of three arbitrators, each an expert in his/her field.

Ideal ADR Agreement

If a commercial dispute is already active it will be difficult to get the parties together in the heat of battle to agree on ADR. Ideally an agreement to follow ADR principals should be built into the commercial relationship from the outset, prior to a dispute developing. The following mediation agreement is guided mainly taking the cost factor into account:

The parties agree that any dispute arising in connection with this (contract, engagement letter, purchase order, proposal) that cannot be settled through direct discussions between us shall be sent to mediation under the rules of mediation of the (mediation service provider). The parties further agree that while the mediation efforts take place, they will not send the matter in dispute to arbitration or litigation.

If a party to a commercial agreement considers mediation will not satisfy its needs due to it’s non-binding nature, the following arbitration agreement is ideal from a cost point of view:

Any dispute arising in connection with this (contract, engagement letter, purchase order, proposal) shall be settled by one arbitrator carrying out the arbitration proceedings in (name of city), in the (whichever) language under the rules of arbitration of the (arbitration service provider).

Resolución Alternativa de Conflictos Comerciales

Opciones para Ejecutivos de Finanzas

Por: Der Hurley CrFA, CFE, MBA *

Marzo 2006

La resolución alternativa de conflictos (ADR, alternative dispute resolution en ingles) refiere a cualquier medio de búsqueda de una solución a conflictos comerciales fuera de las salas tribunales. Las dos formas más comunes de ADR son la mediación y el arbitraje. La mediación y el arbitraje son alternativos al litigio tradicional. Muchos ejecutivos empresariales son atraídos a la mediación y al arbitraje debido a su falta de confianza en el sistema público del litigio mercantil. La opinión entre muchos ejecutivos es que los tribunales mercantiles están saturados con casos y el proceso es lento y costoso.

Al compararse entre la mediación, el arbitraje y la litigación, los ejecutivos deben tener presente que los jueces son financiados por el erario público mientras que los mediadores y los árbitros son pagados por las partes en conflicto. El problema principal asociado con la litigación tradicional no es tanto su costo sino el factor tiempo en esperar una decisión final. Los ejecutivos que entran a un litigio en buena fe no tienen ganas de hacer frente a los amparos y las apelaciones inevitables. Además, como una litigación se financia por el erario público, su contenido es de información pública. Los ejecutivos empresariales usualmente preferirán que su controversia comercial no sea puesta al aíre en programas de noticias televisivas. Por otro lado, muchas veces los ejecutivos de finanzas se sorprenden cuando se dan cuenta que tienen que liquidar facturas cuantiosas por el concepto de arbitraje. Para realizar el costo beneficio del ADR, los ejecutivos de finanzas deben de involucrarse desde el inicio en la toma de decisiones. Este artículo se enfoca en las implicaciones financieras cuando se opta por el ADR y que hacer para evitar gastos excesivos en el camino.

Mediación

La mediación consiste en facilitar un acuerdo entre las partes en conflicto. Los mediadores son individuos que juntan a las partes involucradas para negociar un acuerdo entre las mismas. Las partes en conflicto tienen el derecho de aceptar o rechazar el acuerdo propuesto por el mediador. El principal atributo de la mediación es que el proceso es ágil. Su principal defecto es que se necesita de la buena voluntad de las partes para ponerse de acuerdo. En casi todos los conflictos comerciales esta involucrado el dinero de por medio. Si una de las partes no puede o no quiere pagar, puede aprovechar de la mediación para prolongar aun más el conflicto y así ganar tiempo. Un ejecutivo de finanzas debe estar pendiente de esta posibilidad cuando apruebe un acuerdo para mandar un conflicto a mediación. Si cada participante en un conflicto comercial considera que su contraparte esta actuando en buena fe entonces es muy probable que la mediación sea el recurso óptimo para resolver la disputa.

Arbitraje

El proceso de arbitraje involucra a un árbitro o un panel de tres árbitros revisando las evidencias de la controversia comercial para después decidir en una solución. Es parecido a una litigación tradicional pero sin las formalidades legales. La decisión o laudo del árbitro es aplicable forzosamente a las partes en conflicto y no es apelable. Allí esta el gran atractivo del arbitraje, los ejecutivos empresariales no tienen que preocuparse por amparos ni apelaciones. No es tan rápido como la mediación pero es mucho más eficaz en términos de respuesta/tiempo que la litigación tradicional. El proceso de arbitraje es más caro que la mediación pero evita el defecto de la misma por el carácter coercitivo del laudo arbitral. La base legal para el arbitraje en México y en casi todos los países que practiquen el comercio internacional es el acuerdo entre las partes para someterse al proceso. Tal acuerdo da cabida para que un laudo arbitral imparcial tenga la fuerza legal de una orden judicial. Si tal acuerdo no existe no hay otra alternativa más que ir a litigar en las salas tribunales. Si una de las partes puede demostrar la existencia de tal acuerdo, el proceso arbitral puede seguir adelante aun cuando la otra parte ya no quiera participar. Legalmente hablando, la otra parte le guste o no, tiene que someterse al laudo arbitral porque ya había acordado ir al arbitraje previamente. Como podría ser en el caso de la mediación, existe el riesgo de que una de las partes no pueda o no quiera pagar lo que el arbitro determine. Quiere utilizar el proceso de arbitraje para extender aún más el tiempo del conflicto buscando piedras en el camino para después pedirle a una sala tribunal que rechace el laudo arbitral. Los ejecutivos de finanzas deben hacer su debida diligencia para medir este riesgo antes de iniciar un proceso de arbitraje. El peor de los escenarios sería cuando el director de finanzas primero tenga que autorizar el pago por una mediación, posteriormente el pago de un arbitraje y después, para el colmo, las facturas de una litigación.

¿Cuales son los Costos de ADR?

Los costos de mediación incluyen los honorarios y gastos del mediador; los honorarios y gastos de cualquier perito solicitado por el mediador con el consentimiento de las partes; los gastos de cualquier testigo que haya llamado el mediador con el consentimiento de las partes; los costos de las instalaciones del proveedor del servicio de mediación si es que estas se usan. El costo de un arbitraje va a depender si el arbitraje es ad hoc o si esta administrado por una institución. Un arbitraje ad hoc esta administrado por árbitros independientes aplicando las reglas de arbitraje de su preferencia. Los costos diarios de un arbitraje ad hoc van a tener los mismos conceptos que la mediación pero el proceso requiere mas tiempo asi que su costo total va a ser mas alto. El costo de un arbitraje administrado por una institución depende del monto en controversia. La institución escogida por las partes cobraría una cuota administrativa más una cuota de honorarios del árbitro, ambas cuotas como un porcentaje del monto en controversia.

¿Quien paga la cuenta del ADR? Generalmente la cuenta esta dividida entre las diferentes partes involucradas. La excepción a esto ocurre cuando un árbitro decide que una de las partes debe cubrir los costos de la otra. Quizás sea obvio que el costo deba ser pagado por las diferentes partes pero esto debe enfatizarse, porque al hacer un análisis de costo-beneficio que compare la mediación, el arbitraje y la litigación hay que tener presente el hecho de que una litigación esta financiada por el erario publico y no por las partes en litigio. El factor costo más impactante relacionado con el arbitraje será la decisión de escoger a un árbitro o a un panel de tres árbitros. Si la controversia es técnicamente complicada, la literatura sobre el arbitraje generalmente recomienda tener tres árbitros. Pero desde el punto de vista de costos esta decisión va a resultar en la triplicación del costo diario por los servicios que ofrecen tres árbitros. Es justificable desde el punto de vista de costos la decisión de nombrar a tres árbitros cuando se estima que es necesario pedir la opinión de peritos en la materia. Teniendo en el panel un árbitro que ya es un experto en el tema va a evitar el costo de pedir la opinión de un perito. Otro factor a considerar va a ser el idioma del proceso de arbitraje. Si las partes deciden que el proceso va a ser bilingüe deben considerar el costo de traducir el testimonio de testigos y las evidencias documentales. Un factor más para considerar es el lugar del arbitraje. El lugar ideal desde el punto de vista de costos será el que minimice los gastos de viaje de los participantes en el proceso arbitral.

Los Árbitros Ideales

El árbitro ideal es una persona integra, imparcial en la redacción de un laudo, y totalmente independiente de las partes en conflicto. Tiene que ser una persona discreta que sabe mantener la confidencialidad del conflicto. Un árbitro esta obligado a escuchar equitativamente a ambas partes. Un arbitro tiene la obligación de llegar a un laudo justo aun cuando una de las partes no participe en el proceso. Si una de las partes decide no participar, aunque debería por la existencia de un acuerdo anterior, el árbitro debe dar al no participante notificación debida del proceso. Un árbitro tiene que tener conocimiento del procedimiento de arbitraje. Aunque no tiene las formalidades legales, el proceso de arbitraje tiene sus reglas. Un árbitro tiene que aplicar las reglas estrictamente para dar un trato equitativo a las partes y para asegurar que su laudo va a tener la misma fuerza legal que una orden jurídica.

La profesión del árbitro ideal va a depender en el tema en controversia. Una de las partes quizá vaya al arbitraje buscando piedras en el camino para ganar tiempo. Si es el caso, a la otra parte le convendría buscar un abogado experimentado como árbitro. Si el conflicto es sobre un tema técnicamente complicado sobre por ejemplo la tecnología informática, en este caso el candidato ideal sería un ingeniero en sistemas. En una controversia en la industria de la construcción quizá un arquitecto o un ingeniero civil sería el mejor árbitro. A final de cuentas casi todas los conflictos comerciales tienen que ver con el dinero. Si el cálculo de valor es el tema principal, un contador seria el árbitro ideal. Si el tema en controversia es legalmente, técnicamente y financieramente complicado entonces un panel de tres árbitros sería la decisión optima, cada árbitro un experto en cada área.

El Acuerdo de ADR Ideal

Si un conflicto comercial ya esta activo será difícil juntar las partes para lograr que se pongan de acuerdo en iniciar un proceso de ADR. Lo idóneo sería tener el acuerdo desde el inicio de la relación comercial, antes de iniciar un conflicto. El siguiente acuerdo de mediación esta influenciada principalmente por el factor costo:

Las partes están de acuerdo en que cualquier conflicto que derive de este (contrato, carta de acuerdo, pedido, propuesta) que no pueda ser resuelto por medio de negociaciones directas entre nosotros será enviado a mediación en la ciudad de (México, D.F., Guadalajara, Monterrey, Puebla, etc.) bajo las reglas de mediación del (proveedor del servicio de mediación). Las partes también acordaran que mientras se lleven a cabo los esfuerzos de mediación, no mandarán el conflicto ni a arbitraje ni a litigación.

Si una de las partes considera que la mediación no satisface sus expectativas y quiere ir directamente al arbitraje para la resolución final de un conflicto comercial el siguiente acuerdo de arbitraje sería ideal desde el punto de vista de costo:

Cualquier conflicto que derive de este (contrato, carta de acuerdo, pedido, propuesta) será resuelto por un árbitro administrando el proceso arbitral en la lengua española en la ciudad de (México, D.F., Guadalajara, Monterrey, Puebla, etc.) bajo las reglas de arbitraje del (proveedor del servicio de arbitraje).