Dr Richard Leblanc

I am giving a speech in later today on the ethics of conducting proper workplace and board-level investigations. (See slidedeck here.) The evidence shows that many investigations conducted suffer from serious setbacks that need to be corrected to be effective. The impetus for change is the new Securities and Exchange Commission (SEC) “whistle-blowing” rule that permits employees now to go directly to the regulator with a complaint and completely bypass the company’s internal processes. I remember when Mary Schapiro, the SEC Chair, spoke to about 700 corporate directors at a conference I attended at the time the rule was being developed. Schapiro said the rule was the right thing to do to address toxic workplaces in the aftermath of the Madoff fraud – which was presented to the SEC but ignored. Directors then and now voiced stiff opposition to the rule, saying it would result in “bounties” (monetary rewards) to employees.

Not only are rewards a good thing to incent employees to come forward, but companies, I will argue in my speech today, should match these rewards for employees to come forward with concerns of fraud and ethical wrongdoing.

The practical effect of this new rule is to put the heat on many companies and corporate boards to reexamine their workplace investigations of potential wrongdoing – and that is a welcome development.

Where do investigations go wrong? Three key areas:

1.         Lack of Anonymity and A Protected Mechanism for Employees to Come Forward

Employees are rational. Why would anyone – especially executives – come forward if they know their identity will be revealed, the complaint will not be properly investigated, and they will suffer scorn and even retaliation? What happens then is the wrongdoing festers and gets worse, when it should have been addressed earlier. It becomes part of workplace culture. The identity and personality of the person are largely irrelevant. What is relevant is the nature of the complaint itself. Without a system that guarantees anonymity, an important source of intelligence is suppressed.

2.         A Weak Audit Committee and Board

Boards now need to know what best practice reporting channels are and when to get involved and even lead an investigation of conduct that involves management and can put the reputation of the organization at risk. This is changing now with contagion and social media.

Employee and culture surveys, informal walk-arounds, and a strong internal audit provide excellent intelligence. There is a natural tendency for management and company lawyers to unduly influence the investigation, which is a red flag for employees not to come forward. The audit committee should have its own independent advisors to receive the complaint directly, and then communicate with management on behalf of the audit committee. If the complaint is serious enough, independent advisors should lead the investigation, not management.

3.         Flawed Investigation and “Lawyering Up”

There is a tendency to become defensive and even passive-aggressive with very serious allegations. Who is on the investigation team, how documents and other evidence are preserved and collected, how interviews are conducted, and how upward reporting occurs are very important and will determine how conclusions are viewed by regulators and other stakeholders. Self-reporting and ready co-operation to cure the complaint can be viewed favorably by regulators and the public. The best example of proper crisis management is Maple Leaf Foods when its CEO Michael McCain publicly apologized and promised to make it right. See the video here. Lawyers have a tendency to hone in on process and not see the bigger public relations picture and opportunity.

Conclusion:

In the age of social media, simply an employee with a cell phone may publicly trigger an investigation. The consequences of not being ready, conducing a flawed process, or being defensive, can be more damaging to the company’s reputation than the original allegation. (Just ask Mitt Romney, who may have lost the election as a result of ill-advised off-the-cuff recorded remarks.) A company’s actions are now one step away from going viral. The scrutiny and risks have never been greater.

Employees, the media, customers and others need to have confidence that an issue when it surfaces is being investigated independently and appropriately. Good boards are insisting on advance planning and investigation protocols, and warning employees that all actions are public. Maybe Mitt Romney’s team should have done the same.

The former chair of Ornge, Rainer Beltzner, alleged that former CEO Chris Mazza’s compensation included unauthorized payments made without supporting invoices and that “the board was in the dark about many components of Dr. Mazza’s compensation that company executives were paying him over and above his base salary of $500,000 and bonus pay. The board arrived at the bonus pay based on Dr. Mazza’s own evaluation of his performance, Mr. Beltzner said.” See “Ornge board in the dark about aspects of former CEO’s pay.”

If this allegation is true, this is absurd that a CEO would evaluate his own performance and the board would be ‘in the dark’ about the CEO’s pay, including by the chair. The most important thing a board does is select and pay the CEO. The CEO should not even be in the room when the pay is being discussed. This is governance failure and that it is a crown board is even more embarrassing. Ministers should receive reports on board reviews from their boards. There is no such thing as a rogue board as the Minister Deb Matthews said, if you have proper reporting and accountability. There is a pattern here in Ontario. It harks back to e-Health and the Ontario Lottery and Gaming Corporation scandals.

Ontario’s twenty-five ministers oversee dozens if not hundreds of agencies, boards and commissions. It is folly to expect that ministers can have adequate oversight over so many boards under their portfolio without proper reporting and data. Ontario should take a sheet out of the playbook of another province, Saskatchewan. The Crown Investments Corporation of Saskatchewan (CIC) has a comprehensive reporting regime in place for reporting to the Government shareholder for all crown corporations. I had recommended for CIC tough, hard-hitting governance reviews and questions, for the board, major committees, and individual directors, with reporting obligations up the chain, as well as training for all Saskatchewan directors and chairs. CIC also has company secretaries sit in on board meetings. CIC’s governance overview is best in class in Canada in my view. I doubt some of the shoddy governance practices we have witnessed in Ontario would have survived this scrutiny and reporting regime.

Governance is not government. Ministers’ goals are to get re-elected. Ontario corporations are a public trust on behalf of taxpayers. The Government of Ontario should impose the same accountability practices on itself that it imposes on regulated companies. It should lead by example.

The Ontario Securities Commission has asked whether proxy advisory firms should be regulated. (Proxy advisory firms, such as Institutional Shareholder Services and Glass Lewis, which is owned by Ontario Teachers Pension Plan, provide governance assessment and recommendations to institutional shareholders on their voting at annual meetings of companies.) In my view, proxy advisory firms should be regulated for three important reasons.

Conflicts of Interest

Proxy advisory firms also provide consulting services to companies to improve their governance score. This would be analogous to me as a teacher providing tutorial services for money for students to improve their grade. Or credit rating agencies receiving fees for other services other than an independent rating of creditworthiness of the company. The business model for proxy advisory firms needs to change such that there is no non-assessment services offered by them. Similar to auditors being restricted only to the audit, and compensation consultants being restricted only to compensation assurance services, any firm charged with independent assurance of governance should not have a consulting revenue stream. Having an alternative revenue stream to an assessment undermines the independence and objectivity of the assessment, and the appearance and confidence in the marketplace that the assessment is not unduly influenced by proprietary interests.

Lack of Qualitative Assessment of Governance Quality and Predictive Validity on Shareholder Value

Second, there is limited peer-reviewed evidence that proxy advisory firms actually measure governance quality, or that what they do measure predicts shareholder value. These are commercial firms whose business model is predicated on volume-based, externally measureable metrics. What is measureable, such as structural independence governance metrics, such as separate chairs and director independence, does not necessarily impact board effectiveness or shareholder performance, the research shows. What is relevant are qualitative factors like board and director qualities, culture, judgment and circumstances. These are more difficult to measure from outside a boardroom. We see the inconsistencies in proxy advisory firms’ ratings where the same company receives divergent ratings from different proxy advisor firms, or companies that experienced governance failure formerly received high ratings. Proxy advisory firms should be required to assess and incorporate qualitative and firm-specific factors into their ratings and recommendations, with a process for independent review, audit and arbitration if necessary. The personnel and sources consulted to produce a proxy advisory report should also be disclosed. See the paper by Leblanc et al., here under “The Governance of Proxy Advisors.”

Lack of Transparency

Third, the transparency of proxy firms should be increased. Proxy advisory firms’ rating methodologies and weightings to various factors are divergent. If they were measuring governance quality with rigor, we would expect to see convergence. Not surprisingly, individual companies may receive different ratings depending on the proxy advisory firm. This inconsistency needs to be addressed. Governance ratings according to Stanford researchers who study them were found to have little predictive validity among the ratings of any of the three proxy advisory firms examined. The authors go on to write (Larcker and Tayan, 2011, p. 446-447), “the study found low correlation among the ratings of the three firms, low correlation between the ratings of each firm and future performance, and low correlation between the ratings of Risk Metrics/ISS and the proxy recommendations of Risk Metrics/ISS. The authors concluded that “these governance ratings have either limited or no success in predicting firm performance or other outcomes of interest to shareholders. … Our view is that  … the commercial ratings contain a large amount of measurement error. … These results suggest that boards of directors should not implement governance changes solely for the purpose of increasing their rankings.” They further examine governance rating systems by academic researchers and conclude that predictive ability of a rating index on future firm performance has not been reached.

The use of and reliance upon ratings and proxy advisory services by institutional shareholders should also be transparent and accessible on the institutional shareholder website. (See the above paper.)

Boards of directors criticize proxy advisory firms for their ‘check the box’ and ‘one sized fits all’ approach to corporate governance; the enormous influence that they have; and their lack of transparency and accountability – in the governance field – when these firms and shareholders they serve insist on it from others. It seems to me that there is merit in concerns that boards have.

Hundreds of former players are suing the National Football League and equipment manufacturers for head injuries and other damage, saying concussion data was ignored by the league and it had a duty to protect players.

This litigation could be precedent for a similar lawsuit against the National Hockey League. Concussions and the associated neurological damage are a problem in Canada’s game – “the fastest game without an engine.” The players and equipment are bigger, faster, stronger and harder, but the rinks and rules of the game have not kept up. And we have credible medical evidence now that we didn’t have before.

For examples of concussion damage, see “Concussion numbers were staggering in NHL’s 2011 and 2012,” the YouTube video “Suffering in Silence: NHL concussion issue,” more press here and here, and USA Today’s “NHL concussion tracker” (with 100 pictures).

See just some of the medical evidence here, and Peter Mansbridge’s coverage of the “Brain Lab That Could Change Hockey.” And, as many hockey fans know, Sidney Crosby’s performance may never fully recover from hits to his head.

The question is, is the NHL’s Commissioner, Gary Bettman, listening? What about the board?

Sporting governance is shrouded in mystery. Transparency International, in “Corruption and sport: building integrity and preventing abuses,” writes,

“There is generally a low level of transparency in many sport associations when it comes to publicly sharing information and documentation. This often linked to the disclosure practices of team owners — who are often individuals or companies. This characteristic is troubling given the process for making internal decisions and conducting elections in national and international sport organisations. Board members of international federations as well as members of working committees are often expected to vote unanimously, with dissenting votes not registered in the minutes. Such practices prevent any real accountability, both for the boards and for sport in general.”

In analyzing boards, I scrutinize the governance practices of the organization, compared to best practice, and how decisions were made, or not made. Here are just some issues I see with the NHL’s governance:

• Gary Bettman has been NHL Commissioner (which means “CEO”) since 1993. A tenure of almost 20 years for any CEO is highly anomalous. I would want to know the NHL Board’s plans for CEO succession, and whether it meets in closed session to discuss succession. I would also want to see Mr. Bettman’s position description, which is common now for CEOs.
• Mr. Bettman’s salary was, according to the National Post, US$7.5M for the year ending June 30, 2010. It was 3.7M in the 2004-05 season. Here, I would want to know how Mr. Bettman’s salary and incentive structure is set by the Board, what the performance metrics are (e.g., expansion, relocation, revenue targets, growth rates, television and radio metrics, etc.), and whether the metrics and compensation are risk-adjusted, including health and safety. I would, in short, examine how Mr. Bettman’s compensation drives his behavior.
• Every board has to identify and oversee risk. Here I would want to know the reporting and assurance protocols the NHL Board used and/or rejected for incorporating medical evidence for concussions in its oversight of management, rule-setting and strategy for the league.
• Every board has to have a reporting and accountability structure independent of executive management. Here I would want to know why the Board meets only twice a year (see “NHL’s secret constitution revealed”), what independent directors sit on the board, what the reporting and decision-making structures are, how rule-setting occurs, and the independent assurance and internal controls over player safety and league reputation.
• Lastly, I would want to know why there is minimal at best disclosure over governance on the NHL website. There are opportunities for development in this regard.

As the lawyers allege in their statement of claim suing the NFL:

“The NFL, like the sport of boxing, was aware of the health risks associated with repetitive blows producing sub-concussive and concussive results and the fact that some members of the NFL player population were at significant risk of developing long-term brain damage and cognitive decline as a result,” the complaint charges.

“Despite its knowledge and controlling role in governing player conduct on and off the field, the NFL turned a blind eye to the risk and failed to warn and/or impose safety regulations governing this well-recognized health and safety problem.”

We will see how this lawsuit plays out. In the interim, perhaps we might consider that the game might be better served by those who lead it coming to grips with advancements in medical research and what it is telling the sport about how the game is being played. Perhaps there are better governance practices in particular that could be put in place in order to help the game thrive in the future.