Going for Broke

Insolvency is all around, but smart CIOs can spot the symptoms of failure before their companies become too sick to save

Anyone wanting to know if their business is insolvent can run a couple of tests. the first is the balance sheet test: When a company has more current liabilities than current assets it is insolvent. The second is the cash flow test: When a business cannot pay its debts as and when they fall due it is insolvent.

In an ideal world, information systems should be able to predict when a company is sailing into financial heavy weather and getting close to passing either test. Ideal worlds and IT departments, however, are rare bedfellows, which explains why so many companies still claim surprise when they find they have been trading while insolvent.

At present, Australia's insolvency specialists say business is quiet, thanks to a still strong economy. In the next breath, though, they warn that insolvency is a cyclical business and troughs are inevitably followed by peaks. But even during the quiet times there are stacks of CIOs and IT managers that learn firsthand what it is like to go to the wall. In 2004 alone, 6618 Australian companies experienced what happens when the administrators are called in, and in the first five months of 2005 another 2649 companies joined them.

Even if your business is safe, the cascade effect of insolvencies along tightly integrated supply chains can be extreme. The failure of one company in a supply chain can affect many other businesses. Early warning systems could at least help businesses plan for the pain.

Under the Corporations Act, although CIOs do not have any specific responsibilities regarding provision of information to directors, the Act does impose certain duties, especially where the CIO can be described as an "officer" of the company. For small businesses, or family-run operations, this is often the case with CIOs and directors being one and the same person. Two high-profile insolvencies just this year involved CIOs who were related to directors of the business. Lincraft, which called in administrators in early 2005 owing $10 million, had as its CIO Michael Sacher, brother of director Earle Sacher. And Collins Booksellers, which had been founded by the Slamen family in 1922, had Fred Slamen as its IT manager.

Sacher, who is now working as a consultant, declined to be interviewed for this piece, and attempts to contact Slamen were unsuccessful. Slamen was, however, already feeling the pressure of running IT for Collins back in 2001 when he told CIO's sister publication Computerworld: "The pressure in this position is often so intense it feels like I'm stuck in a small room with four walls closing in on me."

Do Diligence

The pressure that CIOs face will only increase as the compliance burden rises. As it stands currently, according to Sparke Helmore partner Susan Bennett, under the Corporations Act when CIOs are regarded as an officer of the company they are obliged to:

• exercise their power and discharge their duties with care and diligence

• exercise their power and discharge their duties in good faith, in the best interests of the company and for a proper purpose

• not improperly use their position or information gained as a result of their position to gain an advantage for themselves or someone else, or cause detriment to the company.

In addition, Bennett says, "CIOs, company employees, will be guilty of an offence if they engage in conduct that results in concealment, destruction, mutilation or falsification of any books relating to the affairs of the company or knowingly provide false or misleading information to various persons including a director or auditor of the company".

All well and good, but on occasion it seems management of financially troubled companies does not want to know how things are performing. Nor does it want anyone else to know.

During a committal hearing in July 2005 of Jim Selim, former Pan Pharmaceuticals executive, the company's former computer manager Karl Brooks said that he had been asked to wipe computer disks clean in order to stop anyone being able to recover information from them. Brooks told the court: "Mr Selim said, 'If a computer expert was to access the computer, would they be able to retrieve the data?' To which I replied, 'Yes, if a forensic team was to have access, yes they would be able to retrieve the data'.

Page Break

"Mr Selim replied, 'Can you make it so the data is not retrievable by anyone?' To which I replied, 'I don't know, I could try to do a lower level format, which may or may not work - I'm not a hardware expert'. To which Mr Selim replied, 'Just do whatever you can'."

Brooks also said that Selim also instructed him to change the computer dates so that no one could tell when the data had been erased.

Brooks was given a letter of comfort by the team prosecuting Selim, but whatever the outcome of that case, CIOs need to be aware there is an increasing obligation on all company officers and hence CIOs to keep more and more records. Bennett co-authored a paper with fellow lawyer Ben Stack earlier this year on the need for improved information records management policies. They argue that organizations have to put much greater focus on proper records management. Why? Because, "as courts and regulators increase the severity and frequency with which they sanction organizations for improper information and record management practices, record management must be elevated as a core component of every organization's functions".

The poster child for insolvency and inadequate records management in Australia is HIH. Its information systems were attacked as woefully inadequate by Justice Neville Owen in his 2003 Royal Commission report (see CIO August 2003). With former directors Rodney Adler and Ray Williams now serving jail time, it should send a clear signal to corporations that they need information systems that can alert them to the possibility of financial trouble long before it strikes. It should be at the very top of the corporate governance agenda for every organization. If they do not have that sort of early warning system, they had better make sure that their information records management is up to scratch because the courts are unforgiving towards those companies that are slack over record keeping.

As Bennett and Stack point out, when the liquidators got hold of HIH's company hard drives, laptops and backup tapes, a forensic team was able to restore more than 42 million documents that were analyzed for evidence in the Royal Commission. One database had more than 8000 e-mails deleted the day before the collapse, some of which stretched back to the period before HIH bought FAI. It is proof for doubting executives that you can run from technology but you cannot hide from it.

According to Paul Weston, a partner in the business recovery and insolvency division of Horwath Australia and who has conducted many high-profile administrations including that of the Froggy Group, almost inevitably the companies that do call in administrators, or have them forced upon them, have very poor information systems. "When we are called in, generally the information systems are poorly run. They often have a system that they were told would run the business, but it doesn't," Weston says.

Not that it is generally the fault of the IT staff. The IT department is often provided with insufficient budgets, and the IT budget is one of the first things that gets pared when times do get tough, Weston acknowledges. Then he says a vicious circle kicks in, because the good IT people see the data early, recognize that the company is in trouble, "and the good ones jump ship". The financially troubled company does not replace the staff, and the remaining team is swamped and unable to provide the information reports that might help the business through the crisis. The whole thing goes from bad to worse.

"We don't see over-analysis at our end. If you have too much information then you can usually sift through it to find the fundamentals. But invariably it's the opposite: information is too out of date, or it's inaccurate."

Attack of the Reporting Monster

There are companies, however, that fall into the trap of measuring everything and understanding nothing. There are businesses in danger of being swamped by their systems once they get bitten by the analytics bug. It's not uncommon for an organization to create a reporting monster rather than focusing on the essentials. Just having the data is not enough. There has to be a commonsense analysis of the data.

At a user conference held in Melbourne earlier this year, UK supermarket chain Sainsbury's admitted it had been swamped. Alex Fovargue, the head of customer analytics marketing, said when he joined in 2001, Sainsbury's had 5 terabytes of data stored across 28 nodes and details on eight million customers. But it still found itself planning the coming Christmas promotions without really knowing what the previous Christmas had been like. Fovargue determined quickly what information he needed and discarded the rest.

Most companies would benefit from the business and the CIO sitting down together to work out the eight to 15 KPIs that can be measured and used as a barometer of corporate health. These can then be used to construct a system that can provide management with easy-to-understand amber or red alerts if the company is headed for bother.

Engineering consultancy Parsons Brinckerhoff does just that, with IT and finance working closely together to ensure that the right information reports reach the right people on time. National IT manager Michael McPherson sees his role predominantly as one of creating the computing and communications infrastructure to support the reporting. "The definition of the local data warehouse is a joint effort by me and the financial guru. He then generates the period reports, which are mostly shown as graphs and line charts," McPherson says, although he adds that in the future it may replace that with a Web-like interface to provide easier access to the underlying data.

"This is really about understanding the business parameters in your sector of the economy," McPherson says - which means in Parsons Brinckerhoff's case, a weekly refresh of the key indicators providing management with a seven-day overview of how the business is performing.

Increasingly corporate compliance codes such as Sarbanes-Oxley in the US and CLERP 9 in Australia are encouraging more companies to develop early warning systems. Compliance issues, even for much smaller companies, are starting to affect the quality of financial information systems.

According to Horwath's Weston, the introduction of the GST and the need for companies to submit a regular Business Activity Statement to the Tax Office has prompted some improvement in company record keeping already. "It's still a struggle, but in the main it's better than the pre-GST regime," Weston says.

Page Break

SIDEBAR: Too Much Information

When haberdashery chain Lincraft collapsed early in 2005 it had debts of more than $10 million. But it was not a lack of information that led it into the mire. In fact it probably had too much information and the problem was in part that it was swamped by reports and suffering a form of analysis paralysis, according to Karl Kugler, general manager of finance and administration.

That said, the information systems were providing financial reports that gave directors an early warning that they were heading into financially difficult territory. That gave them and their main creditor - the ANZ Bank - the opportunity to call in administrator KordaMentha earlier this year.

Lincraft has since been rescued in a bailout believed to have cost Melbourne discount chain Dimmey's about $20 million. Not rescued was the CIO position, formerly held by Michael Sacher. According to Kugler, once Dimmey's took over it went on a cost-cutting drive. Kugler now has the IT department reporting directly to him on operational issues - and to the CEO for any budget matters. He is not sure there is the need for another CIO - in part because the business is now scaling back on its information systems.

"Part of the problem was we had too much information," Kugler says. "The buzzword is information paralysis." He says that the new owners have recognized that it is not enough to "rely on the IT systems - you have to apply your common sense too".

Michael Sacher is now working as a contractor and declined to discuss what had happened at Lincraft. Of Kugler's claim that the business had suffered analysis paralysis, Sacher would only say that, "I've got a different version but there's no point in raking up old coals now".

Certainly there is no reason to hide from the experience; it is not as though being a CIO of a company that enters administration - even liquidation - is necessarily career limiting. One of the highest profile insolvencies in recent years was the collapse of Ansett. CIO of the airline was Andrew David, who has since been appointed chief operating officer of Virgin Blue. The public affairs manager was Heather Jeffrey who is now in a similar role at Virgin Blue.

But like Sacher, they are shy. Although both must have learned many lessons from the Ansett collapse, neither was willing to speak about the experience.

SIDEBAR: The Writing on the Wall

According to Sparke Helmore partner Susan Bennett, there is a series of primary indicators of insolvent trading that people can look for. These typically include:

• continuing losses

• poor relationship with bank, including inability to borrow

• overdue taxes

• no access to alternative finance

• suppliers place the company on cash delivery terms

• creditors unpaid outside trading terms

• company issuing post-dated cheques

• dishonoured cheques

• special arrangements with selected creditors

• paying creditors round sums not reconcilable to specific invoices

• letters of demand, summonses, judgments or writs of execution issued against the company

"A CIO would need to examine these triggers to ascertain which are capable of being detected by some form of early warning system, "Bennett says.

SIDEBAR: When the Party's Over

Once an administrator has been appointed to a company, he or she is the new boss. Any previous reporting lines are erased, and the CIO is accountable directly to the administrator for as long as the company trades in administration.

Quite often the period of administration does not last very long (maybe a few weeks or months), especially if the company is able to haul itself out of administration with the creation of a deed of company arrangement. But as Horwath insolvency expert Paul Weston says, however long administration lasts, it is a period when you've got a lot of nervous employees. "It's a very difficult time, but we do need them and work closely with them," he says. "Invariably the IS and financial people can see where we are coming from and that we do appreciate them. But they certainly know that it is short-term and there is a problem retaining people during administration, especially in IT."

While these staff remain during administration, their normal salary is paid by the administrator. However any entitlements such as holiday or long service leave need to be negotiated alongside the entitlements of any other creditors. If a company goes into liquidation then it is still possible to continue to trade some or all of the operations, and at that time the CIO would report to the liquidator.

According to Sparke Helmore partner Susan Bennett, if the CIO can be defined as an officer of the company then he or she would be responsible for identifying or delivering all the books to the liquidator, provide all information that the liquidator reasonably requires, do what the liquidator reasonably requires during winding up, and provide his or her residential and work or business addresses if required.

"CIOs failing to comply with these obligations risk being prosecuted for offences under the Corporations Act," she warns.