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Archive for the ‘Ethical Leadership, Citizenship and Integrity’ Category

Why integrity is good for business, and the role that boards play

“We didn’t know.” “We missed it.” “It was a rogue employee.” There is not an excuse I have not heard for ethical failure. But when I investigate a company after allegations of fraud, corruption or workplace wrongdoing, almost always there is a complacent, captured or entrenched board that did not take corrective action. In a few cases, boards actually encouraged the wrongdoing.

The first myth is that the board is a “good” board. There is no relationship between the “glow” or profile of directors and whether the board is “good.” Often times, there is an inverse relationship, as trophy or legacy directors typically lack industry and risk expertise in recognizing fraud or understanding what proper compliance looks like, are not really independent, are coasting and not prepared to put in the work, or they themselves may not possess integrity.

How important is integrity? Extremely. Three factors make for a good director or manager: competence, commitment and integrity, with integrity ranking first. Otherwise, you have the first two working against you.

Integrity needs to be defined, recruited for, and enforced. “Does your colleague possess integrity?” “Yes” is an answer to this perfunctory question. Full marks. But when I define integrity to include avoiding conflicts of interest, consistency between what is said and done, ethical conduct, and trustworthiness – and guarantee anonymity, I get a spread of performance scores. Those who do not possess integrity in the eyes of their colleagues are poison and should are extracted from any board or a senior management team. They never should have been elected or hired in the first place, which is a recruitment failure.

Fraud, toxic workplaces, bullying, harassment and pressure do not occur in a vacuum. Many people in the company know. The issue will not go away, will only get worse, and is a latent legal, financial and reputation risk.

For bad news to rise, boards need to ensure that protected channels exist and are used – including for a director or executive to speak up in confidence, and for an independent consequential investigation to occur.

Ethical reporting also needs to assure anonymity to the fullest possible extent to receive reliable information. If a whistle-blowing program has any manager as the point of contact, it is not effective. Whistle blowing, culture surveys, and ethics audits should be conducted independently and reported directly to the board without management interference.

Frequently, I find ethical design and implementation failure are the culprits, with codes of conduct, conflict of interest policies, whistle-blowing procedures, culture and workplace audits, and education and communication being perfunctory at best, overridden by management at worst, and not taken seriously by employees or key suppliers, with minimal assurance and oversight by the board.

Complacent boards and executives are the last to know and deny any wrongdoing, having creating the conditions for fraud to flourish. Shockingly, lacking any pride, in full denial, and further reinforcing their entitled self-serving mindset, they refuse to resign.

After ethical failure happens, executives argue that it is a lone rogue employee or an isolated incident. Nothing could be further from the truth. It is an employee who reflects the true and actual culture, internal control environment, and practices of the organization, and who is attracted to and flourishes within them. There is no such thing as a rogue employee. It is a board that approved the conditions that management proposed within which employees operate. The board’s leverage of approval, documentation and questions went unused and unasserted. They are the very people who should not be overseeing subsequent reforms, as they are assessing their own shoddy work.

This lax control environment, where self-interest is pursued and where pressure is applied, is the heart of ethical failure.

There is a shocking lack of internal controls over employee and agent behavior that I have found in corrupt jurisdictions in which Western firms do business. This means, not only is the potential for fraud rampant, but also that costs of compliance are being borne by companies who do not bribe and have proper controls. They are penalized for doing things right.

Furthermore, there are corrupt jurisdictions whose companies and government officials offer and receive bribes and advantage themselves over Western counterparts, including in Russia, China, India and MENA. The most recent example is bribery allegations at FIFA. This unequal playing field puts Western companies – in the US, UK, Canada and elsewhere – at a disadvantage, when competing for business, opportunities and contracts.

This is why Western governments are seeking to put their countries and companies in the most competitive position possible. They are enforcing anti-corruption laws using long arms of justice to prosecute bribery. They are also debarring companies from government contracts who commit ethical breaches. This debarment is a powerful motivator to spur investment to internalize the costs of internal controls over integrity.

Western industry will mistakenly argue that integrity laws will disadvantage them or cost their industry jobs, but the reality is the opposite. Tough integrity laws will prevent substandard competitors from offering bribes, will disincent recipients from receiving bribes, and will strengthen Western companies who compete on the basis of price, quality and service.

When does it become unethical for a director to continue to serve?

I spoke to corporate and not-for-profit directors in Dallas, Texas, today, about board dynamics and board renewal. The subject of the length of board service and director retirement arose. I said there was a recent study that the optimal service for a director was nine years, beyond which firm value was adversely affected. Many directors serve beyond nine years. The most excessive example of long service occurred once when a director of a community bank board said, “Richard we have four directors who have been on our board for over 50 years.” I mistakenly thought that this was 50 years in total, among the four directors. But I was wrong. There were four directors who had been on the board for over 50 years, each.

Many directors hang on to directorships for far too long. I counted several directors who have been on corporate boards for 10, 15, 20 and 25 years. This blocks board renewal, up-skilling, and diversification. Incumbent directors offer reasons for staying: how they know the company, enjoy serving, etc., and are skillful at wiggling, raising the retirement age to 71, 72 and now 75 (from 69 and 70).

The academic evidence however does not support excessively long-serving directors, or directors who are serving on multiple boards (known as “over-tenured” and “over-boarded” directors, respectively). Firm value is adversely affected for over tenured directors (inverted U shape in relation to firm value); and oversight and long term performance are compromised by “consistent and convincing results” (according to Stanford researchers) for busy boards composed of over-boarded directors.

Often the most vocal directors are those who are the least relevant or most affected by renewal. When you do a proper board review, it is apparent who is performing and who is not. There is resistance to an expert third party board evaluation by underperforming directors for fear of being found out. Directors know who the non-performers are. I said to the audience this morning that every board has one (or more) underperforming or dysfunctional directors, and if you don’t know who it is on your board, then it is you.

If boards do not solve their lack of renewal, regulators will do it for them. It is already starting. Regulators in the UK, Australia, India, Hong Kong, Singapore and other countries are imposing term limits on directors of between 9 and 10 years, beyond which independence is questioned. Regulators are imposing diversity requirements on boards. In the UK, even auditors are subject to tendering every five years. Regulators read the press reports of directors serving 40 years, auditors even serving up to 100, and communicate with academics on what the empirical research findings are.

The fact of the matter is that boards, as self-policing bodies, may be incapable of solving the renewal issue on their own because of entrenchment and self-interest. And herein lies the ethical question, posed to me by a director today: “When does hanging on or digging in breach a fiduciary duty by the director to act in the company’s best interest, rather than the director’s?” When should doing what is right; putting oneself at risk; having proper succession planning; mentoring, coaching and developing the next generation of directors; and letting go gracefully and honorably, matter?

This is an integrity issue. If – or perhaps when – a director becomes irrelevant, or is destroying value, is it ethical for that director to continue? Is it ethical for the board to allow that director to continue? The problem is doing what is ethical vs. acting out of self-interest can get commingled in an under performing director’s mind, or even a founder’s mind, or even other directors’ minds (who have been captured by the entrenched director colleague), without an objective measurement. This is neither person-proofing governance, nor in the interests of the company and its shareholders.

Aggrandizing long service, referring to “god fathers,” compounds this renewal problem and wearing as a badge of honor how many boards one has served on, or does serve on. As one “godfather” recently remarked in open session at a corporate governance conference, “We did virtually no research.” Well, maybe research should be looked to more when policy is developed. Firm value and the oversight of shareholder investment are at stake.

Eventually, a director fights redundancy and relevance. A tipping point is reached if there is indefinite service. It is inevitable. No one wants to be irrelevant. If there is no policy or, better yet, no measurement of actual performance and follow up accordingly, self-interest is perpetuated and complacency is allowed to continue, by the very people who should be leading by example. Directors need to know when it is time to go. And if they do not, regulators will.

 

What boards and individual directors can learn from Toronto Mayor Rob Ford and managing conflicts of interest

What is the lesson here for boards of directors and individual directors and officers? Avoid conflicts of interest at all times, but if and when they do occur, the test is perception and process. Every board should have a conflict of interest statement that applies to officers and directors, and to a control person or significant shareholder if applicable. It should cover identification and resolving of the conflict. If you are in doubt as to whether you have a conflict, you must disclose and cannot influence or take part in a decision, transaction, arrangement or otherwise in which you: can be perceived to have an interest, direct or indirect; cannot be seen to be impartial from an outsider point of view; or receive a benefit not shared by other shareholders. If you do take part in the decision, or do not disclose the potential conflict, or attempt to influence the vote, you risk detailed legal scrutiny after the fact to show your conduct was improper and did not conform to best practice. Records of the matter should be kept, a special committee may need to be formed composed only of directors who are seen to be independent in all ways from the matter and the director or officer or shareholder with the conflict, and expert independent advice should be sought. These best practices will protect the board as well as yourself and your reputation that you acted prudently, exercised your duty of care, were transparent, and acted only in the best interest of the company and all shareholders.

Regulators turning up anti-bribery heat on corporate boards: But will practices change?

Russia is one of the most corrupt nations in the world (see a recent anti-corruption story on Russia by the New York Times). It ranks 143rd of all 182 countries on Transparency International’s corruption perception index, with a score of 2.4. Canada ranks the 10th least corrupt country in the world with a score of 8.7. New Zealand is the least corrupt country globally, ranking first with an overall score of 9.5. The US ranks 24th and the UK 16th, with scores of 7.1 and 7.8 respectively. See the “Full Table and Rankings,” where countries can be searched via the table. Lower rankings and higher scores mean the country is perceived as being less corrupt.

Prime Minister Harper visited China, India and Brazil to enhance trade with these countries, which are also some of the most corrupt nations in the world, ranking in at 95th, 75th and 73rd respectively. Libya, which involved the alleged Montreal-based SNC Lavalin bribes of some $56 million, comes in at 168. Within these countries, the governments themselves are the net beneficiaries of much of the corruption, so these politicians are far from motivated to impose reform.

Is it realistic to expect that Anglo-American nations, such as the US, UK and Canada, can impose “Western” will on the very way business is done, and has been done, in some countries for centuries? And if things will not or perhaps cannot change, should home country boards of directors be held responsible for systemic local corruption that may be beyond their control?

Regulators are taking corruption and the role of boards and senior management very seriously. The Securities and Exchange Commission and Department of Justice recently released 130 pages of guidance (see the PDF and other coverage here and here) on the Foreign Corrupt Practices Act (“FCPA”). The US has had the FCPA since 1977. Enforcement and penalties have gone up dramatically in recent years. The UK Bribery Act, from 2010, has some of the most stringent bribery laws in the world. In Canada, we have The Corruption of Foreign Officials Act (since 1999) and the recent guideline from the OSC for issuers operating in emerging markets (see the PDF).

Emerging economies are future markets for Canadian companies. The Prime Minister has a vision for Canada to be an energy supplier superpower. For this to happen, Canada will shift its trade to markets with 100s of millions or billions of consumers and much higher growth rates than our current major trade partner, the US, which could be coping with austerity due to its debt for years to come. Harper was in India last week to boost trade.

What is clear is that there is an enormous disconnect between the home country regulations now being imposed, and host country actual practices on the ground.

What should boards that have operations in emerging market jurisdictions do? Six things. First, if you are doing business in such a market, you need a director with extensive on-the-ground experience at the board table, who can tell you and management what the hotspots are. You should move a board meeting to the jurisdiction once a year so directors can get a first hand look. Second, boards must make it crystal clear to management that if the company is not going to bribe, management must walk away from certain business. And the board must support this and not have incentives that promote bribery. Third, the internal controls over financial reporting must be as strong in the emerging market as it is in the home market. Investment and resource commitments need to be made. Fourth, boards must have their own experts to scrutinize off-balance sheet and related-party transactions and complex structures; validate and assure internal controls; and provide foreign language document translation. Fifth, local auditors should have the same oversight, scrutiny, and as necessary direct contact with the audit committee that the home auditors have. Lastly, there needs to be zero tolerance by the board communicated to each employee and supplier. The UK is even banning facilitating payments, which are regarded as a “tip,” as these may be bribes in disguise.

Companies and politicians are feeling the pain, including on Canadian shores. The Wal-Mart bribery probe has widened beyond Mexico to include China, Brazil and India. The RCMP is investigating the SNC Lavalin bribery allegations, on which I advised a law firm suing the company. I blogged about Sino-Forest, a case of alleged Chinese fraud by a Canadian-listed company. In Quebec, the corruption inquiry has cost the Mayors of Montreal and Laval their jobs and this is only the beginning. There are allegations of kickbacks in cash that may reach other more senior politicians. And Ontario is not immune either. A senior Canadian director remarked that Ontario has a reputation for being “the best place to carry out a stock fraud in the industrialized world.”

Clearly, more work needs to be done. Canada’s corruption ranking on Transparency International may go down in 2012 instead of up.

Trust and integrity in corporate governance

I served on a panel this week with the CEO of a financial institution, among other panelists. We were talking about compliance with emerging governance regulations. The audience was primarily lawyers. Towards the end of the discussion, the CEO made a brief remark about the importance of trust on a board. “Trust is not in any of the regulations,” he said. Quite true. We didn’t have time to elaborate during the panel, but I want to expand on this issue by defining trust and integrity and outlining three types of governance relationships requiring trust, with examples, below.

Trust is crucial in a board environment to promote transparency and accountability. Without trust, there are gaps in oversight and information flow. Decision-making failure can result.

Trust, however, is underpinned by personal integrity. Integrity is the building block of trust.

“Integrity” has a very specific meaning in the governance context. “Integrity” means consistency between what a director says, writes and does. It means authenticity, candor, reliability, confidentiality, solidarity, and a willingness to accept personal accountability and be bound by board decisions and a director’s own role within them.

Most importantly, “integrity” means putting the interests of the organization above your own, and even putting your own reputation or that of the organization at risk in doing so. It means having the courage to take significant principled action when necessary, for the ultimate good of the company. “Integrity” also means using power appropriately and always acting in a way that withstands the harshest scrutiny. Integrity is one of the highest bars in the governance game because the opportunities for self-interest and enrichment are so plentiful.

If a manager or director has defects in integrity, in any of the above examples, others will not trust them.

There are at least three major types of trust in the governance context: (i) Board-CEO, (ii) CEO-C-Suite, and (iii) Director-Director trust.

(i)       Board-CEO trust

First, the board needs to trust the CEO to bring full disclosure and transparency into the boardroom. The CEO will not disclose fully if one or more directors do not possess integrity or the CEO does not. A CEO needs to trust a board that directors will react to candid thoughts and pre-plans in a mature, measured and confidential way. A CEO’s integrity is equally important. If a CEO is defensive, holding cards close to the vest, and selectively disclosing, a board will know this and get frustrated. Crucially, if a CEO ever holds back key information, or misleads the board, there is only one chance. The Board-CEO relationship will be permanently impaired.

I remember one meeting I observed when the CEO sat with arms folded, with a laptop (a barrier as no other directors had a laptop), and was interrupting directors, in an almost antagonistic way. My debrief with the board chair was that there was agreement among directors that they are left with a sense they are not being told everything. I developed a coaching program with the CEO based on improved board-CEO relations, proper disclosure and information flow, and improved body language and technique for board meetings. I also recommended adjusting the CEO’s compensation to include, among other factors, improved board-CEO relations. This worked in the short term, but the CEO still was not trusted by the board and was replaced.

(ii)      CEO-C-Suite trust

Second, trust is important between the CEO and C-Suite. If the CEO is not trusted by the troops, they cannot lead. The board should know what the views are of the CEO by direct reports. In a board review I undertook recently, I canvassed the views of all direct reports to the CEO, otherwise known as a “360 review.” I recommended to the independent Chair that all directors see these views. The C-Suite also had opportunity to express views on the directors and where they could improve, which was very helpful (and eye-opening) to directors. The directors had opportunity to express views on the CEO. What ultimately occurred was dissatisfaction by the C-Suite in the CEO and specifically a lack of trust. The CEO was replaced by the board soon after.

(iii)     Director-Director trust

Third, trust is also important between and among directors. Directors need to trust each other that each director will support board decisions once they occur, will respect confidentiality, will be consistent and honest in what they say and do, and will act only in the best interests of the company. If a director or chair acts out of self-interest, directors will not work as a coherent team. Issues will be avoided because of undue influence, entrenchment and self-gain.

I conducted a peer review recently (directors assessing each other) and it was apparent that one director had integrity concerns by many others. I convened a meeting with the board chair and governance committee chair. Without breaching confidence, I advised of this gap and ultimately the director who had the low integrity rankings was asked to resign.

So building an effective board takes a key step: “Integrity” is an important attribute in directors and officers and contributes to trustworthiness and “doing the right thing” in the interests of the company.

Integrity is so important that it should be recruited for, developed, and assessed. Don’t avoid assessing and having internal controls over integrity. It can be done. And if a director or manager doesn’t possess integrity, they need to go. In the words of Warren Buffet:

In looking for someone to hire, you look for three qualities: integrity, intelligence, and energy. But the most important is integrity, because if they don’t have that, the other two qualities, intelligence and energy, are going to kill you.

Recruit directors and officers with the utmost integrity and replace those who do not have it. Your board will be better for it.


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