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All His Ducks in a Row

As Seen in CFO Studio Magazine Q2 2017 Issue

-BY JULIE BARKER-

KENNETH A. JOHNSON, THE CFO OF THE SEC, WILL NEVER OUTGROW HIS CONCERNS ABOUT AUDIT REPORTS

Looking back, 2010 was a watershed year inside the U.S. Securities and Exchange Commission, when multiple shifts occurred that etched a fault line and established a new era. In the aftermath of the financial crisis where some $9 trillion was lost by U.S. homeowners alone, the SEC was on the hot seat to make sure nothing of the sort happened again. To aid in its role of protecting investors from fraud, the agency reorganized its inspection unit. In addition, the SEC geared up to implement and enforce the many provisions of a bill enacted that July, the Dodd-Frank Wall Street Reform and Consumer Protection Act. And its Office of Financial Management named a new chief financial officer: Kenneth A. Johnson.

With a weighty mandate — to protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation — and a rapidly evolving financial world of split-second trades and complex investment vehicles to oversee, the SEC needed strong internal controls so its probity would be unquestionable and distractions from its mission minimal. The CFO’s office constructs those controls and monitors their effectiveness. The effort Johnson, 43, puts into this area is similar to the pains a private sector CFO takes to manage risk and ensure the company’s continued impact and integrity. However, Johnson cannot ever lose sight of the fact that the SEC operates for the good of the public and it is entirely the public’s money that is being risked. So while every company and federal agency needs to follow relevant laws and regulations, “It’s perfectly appropriate for the public to expect that we would have strong internal controls, given our role,” says Johnson.

In 2010, the SEC was performing less than spectacularly in this regard. The Government Accounting Office (GAO), which conducts annual audits of the SEC’s financial statements, had found six “significant deficiencies that collectively represent a material weakness” in its 2008-2009 audit. Small wonder that on taking office, Johnson focused on the need to beef up internal controls.

Material Weaknesses

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis. — Public Company Accounting Oversight Board

“We’re not looking to hide things, not looking to hope they’ll go away, but really trying to deal with things forthrightly,” says Johnson in an interview with CFO Studio magazine from his office in Washington, D.C.

In 2011, there were no material weaknesses discovered. Johnson remembers his elation. “We were working hard to try to remediate [two material weaknesses from the year before],” he says.

One of those GAO-cited faults regarded the agency’s financial reporting and accounting processes, reflecting the need for tightened controls in areas such as fees collected and enforcement penalties. The other material weakness related to the design and operation of the SEC’s information security and other system controls.

“I remember the day when we heard from our auditors that we had no material weaknesses. That was more than we dared hope for in 2011, and to have reached it was a big milestone,” says Johnson. However, four “significant deficiencies” were detailed in that FY2011 report — including information security, which the SEC tackled with stronger staffing and a series of key investments.

Johnson and his team focused on continually improving controls. The SEC has been investing in its financial systems, and sometimes adjusting a policy or procedure, or introducing a less onerous series of steps to reach the same objective. A branch inside the SEC’s Office of Financial Management was created and tasked with assessing whether the internal controls operate as designed, and whether they operate effectively.

The work has paid off: In FY2015, the GAO found no significant issues at all.

That said, Johnson notes that a couple of big fixes are still needed. Money is in the FY2017 budget request for technology to digitize the process when the agency collects fees from the registration of new securities — such as in conjunction with an IPO—and must track them. An even more time-consuming process ensues when the Enforcement division wins a judgment and the SEC collects payments. “We have to track that [penalty] money as a receivable. Maybe that money’s going to Treasury, maybe it’s going to investors, but we have to make sure we’re recording that receivable on a timely basis, … apply payments to the right receivable, and help manage the distributions,” says Johnson. “There’s a very involved process and we’ve started developing a new system to manage that more efficiently.”

Mr. Johnson Goes to Washington

In October 2016, the Office of the Inspector General reported to SEC Chair Mary Jo White that financial management was no longer one of the agency’s key challenge areas. The office’s CFO, however, can’t stop fixating on internal controls; nor can most CFOs. But Johnson is not an accountant by training and “never envisioned” that he was “aiming to be a chief financial officer.”

Ken Johnson grew up in Houston, did his undergrad work in American Studies at Stanford University, and then, in 1995, went to work for the mayor of San Jose, CA, in the budget office. “That was a great education in the importance of budgets: There’s very little that a government does that doesn’t cost money. So, if you understand the money, you can understand how a government works or how an organization works. It’s also a good lesson in [how] you have to make a budget work. Numbers are not forgiving. You have to make some difficult and practical decisions.”

In 1998, Johnson left the West Coast to get his public policy degree at Harvard University’s John F. Kennedy School of Government. Hired by the Congressional Budget Office (CBO) in Washington, D.C., he analyzed the impact that a given bill would have on the federal budget, producing pages of dissection to support the advice CBO delivers to Congress. From there he moved to the SEC and worked on its budget. He became a Chief Management Analyst for the SEC in 2006, and helped develop the agency’s long-range strategic plan. In that role he also spent time on HR and Information Technology. “A theme through that [career trajectory] was a real interest in budgeting and following the money,” he says. “But I don’t think I actually ever once thought about the idea of landing a CFO position. I was really just hopping from one lily pad to the next, looking for the next opportunity that interested me.”

Furthering the SEC’s Effectiveness

Under Johnson, investment in technology has grown. In FY2011, the SEC’s budget requested $57 million for IT enhancements. For FY2017, the agency has requested $106 million. He says technology, and particularly data analytics, is a “force multiplier for us.” He ticks off three main uses: to uncover fraud, to inform policy making, and to “make sure we know what’s going on in the industry.” The industry includes the 28,000 or so key participants in the securities world.

Data analytics boosts the SEC’s investigative capabilities, helping in an insider trading case “to figure out who called whom when, and to follow the chain of who might have tipped whomever off. That used to take weeks and it was a manual staff effort,” says Johnson.

Like many agencies — and indeed many companies — the SEC tried to engineer case-by-case technology solutions to meet its needs over the years. Today, big-picture thinking is more the norm. The agency has been putting in place common platforms for many of the two dozen divisions and offices. “Those systems can talk to each other much more easily, so it makes us much less stovepiped,” he says.

What Johnson calls his biggest challenge, however, is not tamable: the fact that the agency goes “two, three, four months into the year before we know how much money is available to support our operations. That is a very difficult thing to manage around,” he says.

He enjoys working with Congress and answering legislators’ questions on budget priorities. Part of what he likes about his job is that it exercises both “the liberal arts and the numbers side” of his brain. “You need to understand numbers deeply, but you also need to be able to make cogent arguments… You need to be able to lead in poetry and in prose, work collaboratively with people across a lot of different topic areas. I really like that variety,” he says. And when he finds a problem and can do something about it, “I feel like I can make a difference, and that’s pretty cool,” Johnson says.

Two current initiatives include improving the systems for the enforcement and examination programs and redesigning the Electronic Data Gathering, Analysis, and Retrieval (EDGAR) system for automatic forms submission. Another item the SEC has tackled involves rulemaking to implement financial and securities-related legislation. The agency’s goal is to think more holistically about how a given rule might affect the various participants in the markets. More so than in the past, “we have our economists at the ground floor of a rulemaking,” he says, “at the stage when we’re just thinking through the ideas of how to proceed.” With this change, the likelier result is “policies that make economic sense as well as meeting whatever other objectives we have in mind.”

He adds, “Certainly investing in data, and in better tools to analyze that data, help [with that goal], but that story is much more than just a technology story.”

And Johnson is surely smiling. Writing economically sound rules helps maintain fair markets and thus enhances the SEC’s position as a servant of the people. Getting the resources to focus on these areas became possible because the SEC had demonstrated it had the necessary controls in place to successfully manage its resources.

Original Thinker

As Seen in CFO Studio Magazine Q2 2017 Issue

-BY JULIE BARKER-

ROB FALZON, A 33-YEAR PRUDENTIAL MAN, CONTINUES TO LEVERAGE HIS DIVERSE EXPERIENCE AND OUTSIDER’S EYE TO PUSH FINANCE TO ITS TRUE POTENTIAL

From his office on the 23rd floor of Prudential Plaza, Rob Falzon looks out at the cityscape of Newark and reflects that an executive office is a very pleasant perk. But it’s not everything.

Reorganized out of a managing director’s job and the corner office that went with it in 1992, Falzon went to work in a cubicle, where he learned real estate investment banking, an area of Prudential’s business that was entirely new to him. “It was something that I had limited qualifications for and no experience in,” he says. He figured, though, that he’d gain skills and know-how. Ten years out of grad school at the time, he gambled that he’d make up ground. He threw himself into the new job, and, in less than five years, was again a managing director. From banking, he jumped to another new field: real estate investment management. Falzon spent a decade or so traveling extensively, with dual offices in Parsippany, NJ, and London, U.K., ultimately becoming CEO of Prudential’s European real estate business.

Twice, then, Falzon climbed to success before having to reboot, though the skills he’d developed in real estate investment banking positioned him for the role he took in Parsippany. He calls this career path “nonlinear,” counting “four very different jobs,” including his current one as CFO of Prudential, “in the time that I’ve been here.”

Others might say he took unnecessary detours, but he insists he accrued significant benefits from his professional journey: He learned to think about a whole range of external constituents, whether they were shareholders, debt investors, analysts, rating agencies, or other outside stakeholders. Falzon also picked up “knowledge and sophistication around a broad variety of capital markets, everything from debt to equity and the hybrids that exist in between, and U.S. and international markets, and how those markets function.” He says he uses this knowledge of a variety of constituents and capital markets in his job today.

The New Jersey native returned to Prudential’s Newark headquarters as Treasurer in 2009; three and a half years later he was named executive vice president and chief financial officer, watching over one of the world’s largest financial services institutions, with over $1 trillion in assets under management as of Sept. 30, 2016. His vision as he builds his own high-performing Finance team is based in part on his own experience, which has been marked by fascinating opportunities but no set path. He believes the unusual direction he took has not just broadened his skill set, but has sharpened it, too. It’s no surprise, then, that he advocates individual mobility in career development.

But beyond that, something else has resulted from his peripatetic years: He tends to view the Finance organization as a new frontier. He sees enormous possibility in what Finance does, saying its complexity and potential for impact is underappreciated. He looks at this function— and those who know its language and are fond of its clarity—as a means to enhance value for the entire organization.

Financial Role in Driving Performance

Falzon, 57, is particularly proud of an initiative his department undertook to ensure, as he puts it, that there’s “a good line of sight between operating performance of the businesses and the reported results that we provide, whether to shareholders, bond investors, or to regulators.” The Finance team looked back over five years at adjusted operating income, the main business earnings performance measure, and GAAP reported income, noting the “breakage” between the two.

The analysis identified that 85 percent of that breakage came from two areas: 1) the treatment of currency exchange rates in Prudential’s international business, and 2) the way guaranteed lifetime income living benefit features were treated in the company’s retirement business. Falzon viewed “breakage” in the retirement product line as having no small importance, as guaranteed lifetime income solutions offer growth potential for Prudential, given the demographics of the U.S. and the paucity of Americans’ nest eggs.

In the case of currency exchange rates, Prudential revamped the Japan organizational structure to alleviate the problem, where solid business trends were sometimes obscured due to non-economic volatility included in GAAP net income. In the case of the retirement product, says Falzon, “where market developments created volatility in our hedged risk, we revised the asset-liability management strategy and combined the management of risks essentially into a single entity.” This approach helped improve stability while contributing to higher free cash flow.

The exercise set out to make sure the operating performance of the businesses and the reported results were reasonably aligned. “Reducing complexity and volatility, and improving predictability and clarity, can have a significant impact on…how investors value the company,” says Falzon. “That’s an important issue for the company, not just for Finance.” According to public disclosures, the company’s book value per share grew nearly 14 percent in 2015, the year Prudential took steps to mitigate the effects of foreign exchange rate re-measurement on reported results.

Skill Sets for the Future

In order for the Finance organization to enhance value in that way, Falzon says his team members needed a mix of skills. Those skills fall into two areas: the traditional, technically oriented skills, like accounting and reporting of results; and business performance and growth skills, such as strategy and analysis. “Our best people are the ones who can do both of those really well,” he notes.

Continuing on this skills categorization tack, he says technical accounting and corporate finance skills are table stakes —everyone in Finance needs those. Interpersonal skills are what will help individuals “rise in the organization and lead— leadership and creative problem-solving require the development of soft skills.”

Falzon considers developing talent to be so important that he devotes a significant part of his time to it. Because the talent needs of his and all businesses are under constant pressure from disruptive forces requiring new proficiencies, he is a strong believer in taking a long-term view of needed competencies, and serves on the advisory board for Rutgers Business School. Falzon distinguished himself at Rutgers as an undergrad, winning Phi Beta Kappa membership while earning a B.A. in Economics. (He also has an MBA in Finance and Accounting from Columbia University.)

In helping people to progress in their careers, Falzon encourages them to recognize that they need a mix of skills. Careers spent in a silo aren’t going to develop that breadth of skills, he points out. Young people “ought to be looking at lots of lateral movement” as they build those proficiencies, “as opposed to thinking that every change is going to be a change where they’re moving up the corporate ladder,” he says.

Falzon describes the Prudential as being “maniacally focused on talent.” Finance has a requirement that all employees get 48 hours of formal training per year. Leadership programs for new college graduates, new MBA graduates, and seasoned executives are available, as well as specialized training.

“We’re about a culture focused on our talent, diversity, and inclusion and high levels of collaboration,” he says.

Creating a Global Community

On Falzon’s team of approximately 2,000, roughly one third work outside the United States. He travels regularly to Japan, where Prudential’s single-largest international office is found, and is taking steps since becoming CFO to create a more connected global Finance community. This begins with defining elements that are common to finance, “so no matter where in the world they sit, they know what it means to be part of the global Finance community.”

Understanding, for example, that everyone on the team deals with the month-end close develops cohesion, a sense of mission, and a common experience, says Falzon. In meetings to discover common ground, something else becomes clear: “Whether you’re in the U.S. or Tokyo or Seoul, you know we’re making investments in your professional development and that you have opportunities to progress as a professional, both in terms of the types of experiences you’ll have and career opportunities,” he says.

And there’s another layer to this. With a sense of community and common culture, you get a stronger team and financial processes, Falzon notes. “If you have a sense of belonging to the global Finance community, you have a shared construct in terms of what’s important — if that’s common, you’re going to find that individuals will rally around our objectives, conduct themselves ethically, and treat each other in such a way that’s consistent with our company values.”

Falzon, the Jersey boy who discovered his own pathway, is not a lone wolf. Rather, he is a big believer in community. In 2016, Falzon launched “Finance Forward,” the vision for creating the Finance organization of the future. And to make this vision tangible, going into 2017 and beyond, he’s kicked off a virtual global road trip to even further engage employees everywhere. In addition, he hosts meetings with 60 top leaders, U.S.-based town halls where people live-stream from satellite locations and the replays are made available to global offices. Falzon also takes time to visit offices from Shelton, CT, to Seoul in person.

He says these efforts to enhance connection across the globe are intended to enhance business outcomes and build stronger talent by focusing on collaboration, sharing of best practices, and professional development. It’s one of the most important and enjoyable things he undertakes each day.

Financial Risk

As Seen in CFO Studio Magazine Q1 2017 Issue

CENTRALIZED VS. DECENTRALIZED TREASURY: WHICH WORKS BEST FOR YOUR COMAPNY?

-BY WALTER CIRILLO, Treasurer, Novitex Enterprise Solutions, Inc.

During the last global economic downturn, many companies were caught unprepared by the speed at which events impacted their business. Many CFOs asked questions like, What is our current cash balance globally? In which financial institutions are these balances invested? and, What is our counter-party risk?

Companies with centralized treasuries typically had better visibility and information relating to these questions. However, decentralized treasuries deliver other benefits for many companies.

Will a centralized or decentralized treasury function be best for your company? That depends on the nature of the business. Factors such as global geographic footprint, the similarity of business operations across geographies, and management’s philosophy all weigh in this decision.

Pros and Cons

Treasurers are responsible for managing a company’s assets and liabilities, financial risks, and banking relationships. For businesses with operations around the globe, managing these components is complex.

Some of the benefits of a decentralized treasury structure are: (1) Flexibility, as local operating units or subsidiaries manage treasury in line with local conditions, and the solutions are specific. (2) Knowledge of local markets provides advantages for selecting appropriate debt or investment vehicles, foreign exchange hedging instruments, and banking partners. (3) Local staff may have more intimate knowledge of local regulations, and business/legal/tax/banking environment. (4) Local staff likely takes pride in managing all aspects of the operations.

On the other hand, some of the benefits of a centralized treasury structure are: (1) Economies of scale. (2) Rationalization of costs. (3) Standardized cash flow forecasting. (4) Identification of company’s cash balance and risk. (5) Closer control over investment performance and risk. (6) Greater access to financing and liquidity. (7) Ability to leverage banking and other relationships. (8) Local staff can focus on growing the business.

A particularly strong argument for a centralized treasury is that such a structure allows integrated payables and receivable solutions to achieve straight-through processing, which can help improve a company’s working capital position.

Consider Specifics

A centralized treasury structure seems more efficient, but a key question to reflect upon is leadership’s philosophy toward managing the assets and liabilities of the company. A company’s specific situation, such as degree of international presence, type of business, growth prospects or business cycle, sophistication of ERP system, availability of Treasury Management System, and external factors (global/regional financial crises), all play a role.

Facilitating the trend toward centralization is technology (more sophisticated treasury workstations interconnected with ERP systems), as well as legislation or regulatory changes (i.e., the Eurozone’s move from national payment instruments to SEPA, Single Euro Payments Area, and easing of controls in several emerging markets), and globalization of markets.

However, centralization is not without its challenges. Treasurers need the communication and cooperation of local staff to provide valuable knowledge and information on local rules and regulations. Ultimately, the company that implements a centralized treasury approach will likely be better prepared to manage the risks of the global marketplace.