Corporate Ethics and Compliance – Board Responsibilities

Oct 232008

Dr. Earl R. Smith II
Managing Partner, The Federal Circle
DrSmith@Dr-Smith.com
Dr-Smith.com

I recently finished a turnaround engagement. One of the major problems was the attitude of the CEO towards the details of the financial statements – could not be bothered. He resisted the Board’s pressure to pay attention and responded aggressively when challenged that he was not meeting his responsibilities to the company and shareholders. His dismissive attitudes helped to create a culture of defiance towards the board and a cowboy mentality within the senior team. This allowed the CFO engage in all sorts of unethical behaviors – many of which did real damage to shareholder value. Short summary – the CEO is out of work and the CFO is heading for jail. But the cost of their ethical lapses are still being felt by the shareholders.

The Securities and Exchange Commission generally puts compliance management plans into place in order to comply with the Sarbanes-Oxley Act of 2002 and other subsequent mandates. They also address the new stiffer listing rules enacted by the major stock exchanges. The investor is suffering from buyer’s remorse due to the meltdowns of some of the largest companies because of greed in the boardroom. Boards are organized and empowered to protect the investor from normal business risk factors and to enhance the value of the investor’s stake in the company over time. Annual reports include a section on the risks a company, and therefore the company’s stockholders face and the mitigating factors corporate boards plan to take to reduce the risk. Few annual reports reference poor corporate ethics, or less than professional governance as a high probability risk factor.

Public companies, senior executives and board members may be held accountable for poor ethical behavior in accounting practices, financial reporting, and for ethics and compliance management practices of the corporation. An external auditor and the audit committee review the accounting practices for accuracy and compliance with established accounting practices. However, lack of proper oversight by some boards have allowed crafty CEO’s and Chief Financial Officers to set up illegal off balance sheet liabilities and bilk billions from corporations before being caught.

Compliance management should be part of the corporate cultural and be governed by a strong and enforced corporate code of ethics. Directors serving on key committees such as the Audit committee, the Ethics committee or the Governance committee should take their responsibilities seriously – particularly when they are reviewing the compliance to rules and regulations on the part of the CEO and corporate management. Directors should question everything for accuracy and appropriateness. The level of transparency between the board, the CEO and the Chief Financial Officer should be very high. The Finance committee should be able to speak to and substantiate every unexpected accounting adjustment.

Meeting the challenges of laws such as Sarbanes-Oxley seems daunting, but in fact, company leadership should strive to reach beyond the letter of the law in their ethical practices. Compliance management and ethics should become a valued integral part of the corporate culture. Internal audits should include sections to review the truthfulness of reports. The Audit committee should bring to the board’s attention any questionable issue and the CEO should be required to investigate and act on any ethical problems substantiated. While discretion is important, the CEO should outline to all employees action taken when substantial wrongdoing is uncovered.

Directors and senior corporate management should adhere to the same ethical standards as all other employees. Senior management should devote the time necessary to understand all compliance and control tools in place at all levels of the company. Leadership development – through leadership coaching programs – should include ample time to explore issues of ethical behavior. Leadership development focusing on ethics at all levels of the company will ingrain the ethical behavior expected into all employees. Companies taking such far-reaching steps will have loyal employees having high regards for senior management. Satisfied employees are more loyal to the company and produce better results because morale will stay high. The company will enjoy a return on the investment as investors recognize the value of the ethics and compliance management.

Many of my turnaround engagements focus on the role of the board of directors and governance. Many of the recent corporate scandals have come about because the board was ‘asleep at the switch’. The board – as the representative of the shareholders – is the single most important component in the effort to establish and defend strong corporate ethics. If the board ignores the issue, the risks to the company and shareholders can be very great. The board is also the primary engine for assuring regulatory compliance. After all, the shareholders are the ones primarily harmed if the company is found to be out of compliance in any significant way.

When I engage with boards on this issue, I generally organize both an organizational assessment and board assessment. The assessments produce data that identifies ethical and compliance issues. For a few thousand dollars, boards have discovered significant vulnerabilities – and we have been able to correct them quickly.

Pro-active boards preserve shareholder value – rubber stamp or inattentive ones risk shareholder value. It is just that simple.

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