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Weekly UpdatesTHERE IS AMPLE OPPORTUNITY FOR auditors to improve the efficiency and effectiveness of both in-house and external counsel. Legal services audits are often overlooked, even though they are relatively easy to perform and have the potential of substantially reducing legal costs. An audit of legal services is arguably one of the most important audits to conduct when addressing the areas of regulatory compliance, financial reporting, and operational efficiency.
Some auditors are reluctant, however, to conduct this type of audit out of fear or misunderstanding of how it is performed. A new book from The IIA Research Foundation, Legal Services: Auditing the Process, addresses some of the myths associated with auditing legal services and provides a basic foundation for how an internal audit team can perform the audit with relative ease.
THE MYTHS
There are two myths prevalent in the area of auditing legal services: 1) the focus is on billable hours, putting the auditor in confrontation with the legal team; and, 2) the audit cannot avoid putting at risk confidential and privileged information. Billable hours are a minor part of the audit when compared to audit steps regarding improving legal operations. While the audit does not exclude the review of billable hours, billable hours are not the primary focus of the assessment. In some cases, a successful audit of legal services may be performed without including detailed testing of billable hours.
As for concerns regarding sensitive information, it is easy to audit around correspondence that is either confidential or privileged. In a normal audit of legal services, such documents are usually not a significant part of the items under review. Documents such as letters to the client and office memorandum addressing legal impressions do not necessarily have to be included when conducting detailed testing. In many cases, the legal information sought is a matter of public record, which greatly reduces the need to examine confidential files within the legal department. There are alternative resources, such as courthouse repositories, that the auditor may use to obtain information.
INTERNAL OR EXTERNAL COUNSEL
For organizations that have both internal and external counsel, the audit team must decide where to spend audit time and effort. The decision should be a reflection of the amount of resources allocated to each "branch" of legal services. However the amount of legal resources spent by the two areas is not dispositive when determining where to allocate audit time. Other considerations should include which of the two has the most authoritative power and influence on operations. If both types of legal counsel exist, the audit team should perform work in both areas. Careful planning can greatly improve the outcome of the audit work and related recommendations.
BASIC CONTROLS
The audit team should conduct a preliminary walk-through of legal operations to get a feel for how legal services are requested and processed. Most organizations, whether private or public, use legal services. The problem often encountered is that the requisition process is informal, without clear parameters. In the early stages of the audit, the auditors should assess the inventory of legal services performed for the organization. Ask simple questions such as who is responsible for assessing and tracking the legal work performed. Typically, the auditor will see a plethora of substandard practices in the areas of ordering legal services and processing the requests.
The audit team should look for a long list of basic controls, including:
* Clear approval for the work being performed.
* Aging schedules for services rendered.
* Billing guidelines for those performing the work.
* Adequate supervision for both process and output.
In most cases, there should be a uniform and formal requisition before any legal work is performed. In the test of controls steps, the auditor should identify the various levels of authorization and whether those making the request have obtained appropriate approval before proceeding. A related and common control deficiency in this area is having an initial approval process for legal services, without periodic evaluations of how the legal services are proceeding and whether they should be continued or modified. Management should approve not only the initial engagement, but actively manage the engagement to ensure it is in the best interest of the organization.
Few organizations have a separate committee to approve high-cost legal services or pending litigation containing high risk exposure. Arguably, one of the most desirable features in the area of corporate governance is to have a "legal committee" that oversees critical legal issues facing the organization. It would be imprudent to have this committee look at every aspect of the legal process; however, such a body could provide meaningful supervision of material legal matters.
The auditor also should test whether management uses "aging schedules" for legal work being performed. More sophisticated operations may elect to assign tracking numbers to legal services so that general counsel and executive management can monitor the progress made on each service being performed.
Billing guidelines are another key control. If management does not use billing guidelines, the audit probably has a very material finding in the area of control weaknesses. The guidelines should provide clear instructions for how attorneys should operate when providing services.
The auditor also should test the extent to which legal and executive management supervise the legal process. There should be ample evidence of involvement to help ensure legal services are operating in harmony with organizational goals.
Although these basic controls are illustrative, numerous other controls should be in place. Auditors performing an audit of legal services should include control testing to improve the efficiency and effectiveness of legal operations.
SUBSTANTIVE TESTS
The audit team should start substantive testing by running a variety of analytics. Examples include trending legal expenses from month-to-month and year-to-year. To enhance the data analysis, auditors can measure analytical results against comparable organizations within the same industry. Trending and benchmarking data often has a powerful impact. Tests that are simplistic often yield high results. Auditors should look for spikes and dips in the data set as a beginning point for further testing.
Although billable hours are not the primary focus, the audit team should test to determine whether the rate charged for legal services corresponds to the contract for legal services. Trending hours billed over time, sorted by attorney and by service type, is a meaningful test to perform during this part of the audit.
Other substantive tests include vouching and tracing amounts billed, expenses incurred, and other key financial data associated with the legal process. As with most audits, the internal auditor can conduct substantive tests concurrently with the test of internal controls. Careful planning helps to optimize internal audit time and resources spent on both endeavors.
REPORTING AUDIT FINDINGS
There are several aspects to the reporting process the auditor may want to consider when auditing legal counsel. First, the auditor should include an assessment of whether legal operations are congruent with the goals established for the entire organization. If legal is operating contra the objectives and goals set by executive management, this should be reported.
Other issues the auditor may want to report include addressing the efficiency with which legal services uses allocated resources, with emphasis on human resources assigned to work in that area. The audit team may include examples such as support staff per attorney.
Lastly, findings should be reviewed with the audit client before issuing the report. The internal auditors want to eliminate the risk of confrontation with legal counsel. There is no need to name individuals in the report. The focus should be on the process, not specific attorneys. Also, general counsel should agree to the list of recipients of the report in advance of distribution. This list should be very limited, given the nature of the report.
IMPROVING LEGAL SERVICES
The audit of legal services can lead to meaningful change within the organization. One major objective is to make recommendations that assist legal counsel, while simultaneously improving efficiencies. Internal auditors can make meaningful recommendations regarding the quality of legal work performed. The audit of legal services also easily can lead to a reduction in costs. During the course of auditing legal services, a skillful audit team has the opportunity to provide great insight into ways to improve current legal practices.
JAMES S. FARGASON, LLM, CIA, CPA, CMA, is the Lee D. and Cynthia C. Bloch Distinguished Professor at Louisiana State University in Baton Rouge. He is the author of Legal Services: Auditing the Process, published by The IIA Research Foundation.
To comment on this article, e-mail the author at james.fargason@theiia.org.
EDITED BY DOUGLAS ZIEGENFUSS
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