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Newsletter Nov 2003

News update 2003-11: November 2003
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A monthly newsletter on risk management in financial services,
operational risk and user-developed software from Louise Pryor
(http://www.louisepryor.com).

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In this issue:
1. $1.2 billion was an honest mistake
2. Updating software
3. FSA update
4. I just can’t do it…
5. Newsletter information

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1. $1.2 billion was an honest mistake

About 2 weeks after releasing their third quarter earnings figures,
Fannie Mae had to restate their unrealised gains by $1.2
billion. This was apparently the result of “honest mistakes made in
a spreadsheet used in the implementation of a new accounting
standard.” Honest mistake or not, $1.2 billion is a lot of money:
more than the $70 million of Provident Financial in March, or the
$24 million lost by TransAlta in June (see the relevant issues of
my newsletter for details). It’s reasonably common to see errors of
half a million or so, but they don’t usually make the headlines.

Apparently Fannie Mae picked up the error as part of the normal
processes of preparing their financial statements for
filing. Presumably they failed to pick it up as part of their
review process before issuing the earnings statement. They claim
that the event demonstrates that their accounting processes and
controls work as they should.

Better late than never, I suppose, but I can’t help thinking that
their processes and controls should have picked up the problem at
an earlier stage. We don’t know whether the mistake was in the model or
the implementation (ie, whether they had understood the accounting
standard correctly but had made a mistake in the implementation of
that understanding, or whether they had misunderstood the
new accounting standard). It’s entirely possible that their
reviewing processes don’t separate the two issues, thus making it
harder to find either kind of mistake.

Let me know if you’d like any of your spreadsheets reviewed, or if
you are not sure that your processes and controls are as effective
as Fannie Mae’s. Fannie Mae apparently continue to be proud of
theirs, so self-confidence isn’t necessarily a foolproof guide.

A statement from Fannie Mae is at
http://www.fanniemae.com/ir/issues/financial/103003.jhtml

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2. Updating software

It’s out! The eagerly awaited (by some) Microsoft Office 2003 has
been released, and still in the year of its name, too. And the
first patch, as well. Given that there are still many people out
there still using Office 97, we have to wonder how many will
upgrade. There aren’t huge improvements to the basic Word and Excel
capabilities, and most users don’t even know about half the
functionality that’s there in the older versions anyway.

As I’ve pointed out before, having so many different versions
around can create compatibility problems. It’s not so bad within a
single organisation, where you can hope that IT are on top of the
problem and enforcing uniformity, but one of the claimed advantages
of Office is that it’s a de facto standard. The problem is that
there are just enough new useful features in each version to create
problems when the files are read by older versions (eg, some
animations in PowerPoint don’t work so your presentation looks odd;
VBA, the macro language, changed a lot between 97 and 2000).

Some Excel users will face more serious problems when upgrading to
Office 2003. There were errors in the implementations of some of
the statistical functions in the Analysis ToolPak in Excel 2002 and
earlier, which have been corrected in Excel 2003. This means that a
workbook developed in an earlier version and recalculated in Excel
2003 may produce different results. The differences are described
in Microsoft Knowledge Base Article 828888 at
http://support.microsoft.com/default.aspx?kbid=828888.

The article gives the impression that it is only in rare cases that
the corrections will make any difference. That may be true, but
it’s not very comforting for those people that they do affect. One
of the errors concerns the calculation of the standard normal
cumulative distribution function; the old implementation is
basically wrong out in the tail. Another one comes up in functions
that involve sums of squares: the old version is inaccurate if
there are many significant digits in the data but very little
difference in the values. I don’t find it hard to imagine either of
those situations coming up in practice.

If you think your calculations are affected, you then have to
decide whether to stick with the old version and go for
consistency, or upgrade and cope with the differences.

XLSior would be the ideal tool for checking the results either
before or after an upgrade. (Apologies for the slightly strained
link: see www.xlsior.com for details of automated testing in
Excel).

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3. FSA update

The first edition of a new newsletter, Insurance Matters, billed as
being on General Insurance Issues, appeared this month. It’s
available at http://www.fsa.gov.uk/pubs/other/im_newsletter1.pdf.
It should be compulsory reading for anyone involved in regulatory
matters in a general insurance company, or in a firm that has any
of the activities soon to come under the FSA’s umbrella: mortgage
lending, administration and sales advice; the sale and marketing of
long term care insurance; and the sale and administration of general
insurance policies.

The near-final text on prudential risks systems and controls was
issued at the end of October: it’s at
http://www.fsa.gov.uk/pubs/policy/ps_pru/index.html. The text is
the result of the following consultation papers and their feedback:
CP97 (Integrated Prudential Sourcebook), CP128 (Liquidity risk) and
CP142 (Operational risk). This text is expected to come into force
no later than 31 December 2004. It’s not quite complete yet, as it
doesn’t contain the chapter on group risk, which is still being
consulted on in CP204 (Financial groups).

New consultation and discussion papers out this month:
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CP205 Conflicts of interest: Investment research and issues of
securities
CP206 Miscellaneous amendments to the Handbook (No. 11)

DP24 Liquidity risk in the Integrated Prudential sourcebook: a
quantitative framework

Feedback published this month:
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CP171 Conflicts of Interest: Investment Research and Issues of
Securities
CP186 Mortgage regulation: Draft conduct of business rules and
feedback on CP146

Current consultations, with dates by which responses should be
received by the FSA, are listed at
http://www.fsa.gov.uk/pubs/2_consultations.html

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4. I just can’t do it…

Is missing a penalty kick an operational risk? Am I missing out on
a really good analogy for risk management here? There was a
distinct lack of ecstasy on the streets of Edinburgh on Saturday,
when the English at last failed to snatch defeat from the jaws of
victory. The national press, based in London, thought that the
victory was wonderful. The national press, based elsewhere, were a
bit more circumspect – see “You might think it’s all over, but for
many the nightmare has just begun” at
http://www.scotlandonsunday.com/scotland.cfm?id=1292532003

Meanwhile I can’t help pointing out a couple of the weirder
operational risk related stories in the press recently.

“A German man fired for running up a euro 10,000 bill surfing porn
at work claims he was treated unfairly because his employers failed
to take into account his addiction to Net porn before giving him
the boot.” at http://www.theregister.co.uk/content/6/34075.html.

“Camera phones represent a significant liability or security risk
to business” says Jack Gold of the META group as reported at
http://www.out-law.com/php/page.php?page_id=banningcameraphone1067428194.
He encourages employers to ban them, which may be a slightly
paranoid measure to take.

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5. Newsletter information

This newsletter is issued approximately monthly by Louise Pryor
(http://www.louisepryor.com). Copyright (c) Louise Pryor 2003. All
rights reserved. You may distribute it in whole or in part as long
as this notice is included. To subscribe, email
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news-unsubscribe@louisepryor.com. All comments, feedback and other
queries to news-admin@louisepryor.com. Archives at
http://www.louisepryor.com/newsArchive.do.

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If you’re in or near Edinburgh you shouldn’t miss the forthcoming
performance of Mahler’s 8th Symphony, the “Symphony of a Thousand”, at
the Usher Hall on Sunday 30th November. It should be quite an
experience: Edinburgh Bach Choir, Edinburgh Royal Choral Union,
Jubilo, Edinburgh Youth Choir, and Sinfonia are joining forces for the
occasion. There won’t be 1000 of us, but there’ll be quite a few!

Tickets from the Usher Hall, 0131 228 1155
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