Monday, 19 December 2011

Governance on Olympus

Sorry for the dreadful pun of a title. Its poor quality gives some indication of the struggle I have had, and continue to have, with this important case study in appalling governance. The big question I have been thinking about is what lessons there are for corporate governance outside Japan where this company is based. Is it just too specific to the curious business environment of that one country to have wider significance?

I must start with a brief summary of the salient facts. In April 2011 an Englishman, Michael Woodford, was elevated to the position of president and chief operating officer of Olympus Corporation where he had worked for 30 years. The man he replaced, Kikukawa, was elevated to chairman. Woodford was appointed CEO in October but then removed after just two weeks. He claims this was because he queried transactions that had been brought to his attention by an article in Japanese financial magazine Facta in July.

This reported that Olympus had bought a series of small businesses that were peripheral to its main activities but apparently for very high prices. One of these, Welsh medical equipment maker Gyrus was acquired for $2.2bn, which included a $687m success fee to a middleman through a Cayman Islands registered company. A 31% fee is extraordinarily high and totally out of proportion to the size of the company acquired. Further acquisitions were queried in the days that followed and Woodford fled Japan, claiming his life was threatened. Japanese newspaper reports alleged that huge payments had been made to criminal underworld figures. After repeated denials of any wrongdoing by the company, a halving of its share price, and the opening of investigations by police forces and regulators around the world, it eventually admitted that these payments were actually an attempt to hide investment losses from the 1990's. Three board members resigned but the rest, who had all voted for the sacking of Woodford, remain. They have indicated there will be further resignations but not until after they have appointed new directors.

One of the many curious facts about this most curious scandal is that Japanese investors have been relatively subdued. Calls for resignations of all the board have mainly come from overseas investors which has led to a polarisation. Indeed the board of Olympus has spoken of issuing new shares, presumably to a 'friendly' party, which would have the effect of diluting the overseas shareholders who are vociferous in their criticism.

It would take too long to rehearse further facts of the case (for latest developments see here), I must turn to the issues;

  • How have internal and external auditors missed such huge losses (around $1.5bn) over so many years and what sanctions do they face?
  • Were they in collusion with management?
  • What are the Japanese regulators and police doing, since such a huge falsification of accounts is surely criminal?
  • Why are Japanese investors still so quiescent when they have lost over half their investment and they too have been seriously misled?
  • The board of Olympus comprised almost exclusively company 'insiders'. Will this be an impetus to corporate Japan to start appointing genuinely independent directors who will challenge management?
  • How on earth can the board that presided over this debacle still be in office and in charge of appointing their own successors?

The biggest question of all is why there seems a (possibly unspoken) conspiracy of collusion and closing of ranks between company executives, shareholders, regulators, police and government. Clearly Japan is a curious place where identity and loyalty are more important than cleaning the stables and punishing wrongdoers. The disgrace in this case does not just lie with Olympus but with corporate and government Japan.

Although a case like this occurring in the UK or USA would have resulted in arrests by now and a removal of the entire board I think there are still lessons on corporate governance for all of us outside Japan. The most important is that good corporate governance is not just about publishing codes of conduct: people may flout them. It demands that all stakeholders in the company live up to their responsibilities;

  • Auditors must do their job properly
  • Shareholders must not collude with the people who betray them
  • Lenders must not support disgraced management
  • Regulators must act swiftly and decisively to maintain trust
  • Directors must be willing to challenge their colleagues
And let us not be too compacent because we are not Japanese. I will write separately about the results of the investigation into the collapse of Royal Bank of Scotland, one of the biggest banks in the world. Despite having a board packed with big names from the world of business, we are told that nobody really ever effectively challenged a domineering chief executive in Fred Goodwin, neither fellow directors nor the regulator.

Friday, 14 October 2011

The Boardroom Conversation

Unless key figures in an organisation live company values and are prepared to speak up, corporate governance policies are pretty much meaningless.....see my piece on the Boardroom Conversation in Financial Director

Update for "women in the boardroom"

Politicians love easy wins: they love good news; so UK government ministers are positively ecstatic that their calls for greater representation of women in corporate boardrooms has borne fruit after just a few months. Figures published by Cranfield Business School show that FTSE 100 companies have moved from 12.5% representation to 14.2%. Whoopee!

But look more closely. Out of 21 female appointments to FTSE 100 companies in the past six months, 18 are non-executives. So there is no evidence that promotion of women within companies is improving. Also the number appointed to a wider spread of FTSE 250 companies was only 28 - so just 7 for companies ranked 100 to 250.

Now it is movement and it may be a good thing but it still misses a large part of the point - diversity in the boardroom is good but equality of opportunity is better and demands changes to recruitment, development and promotion practices below board level. How many of those 28 had kids?

See my posts on discrimination in recruitment  and on discrimination against women in particular

Friday, 9 September 2011

Psychopaths in the boardroom

A recent Horizon television programme for the BBC discussed the physical differences of psychopaths, whether noticeably different brain functions or differences in key genes. One of the principal researchers in this field, who appeared on the programme, reported that he found no less than sixteen murders committed by members of one branch of his family, over several generations. He also found that he himself had the gene that predisposes its carrier to this condition, attributing his lack of symptoms to a happy childhood and proposing that the gene on its own does not cause the condition but needs to be triggered by stressful influences such as childhood abuse.

Towards the end of the programme a New York psychologist, Paul Babiak, recounted his research that shows psychopathic characteristics are found disproportionately amongst top executives. Why should this be found amongst the most successful? Because the characteristics of the psychopath revolve around a lack of empathy for others and a need to take big risk. So the psychopath can be ambitious, manipulative and ruthless, without qualms and they will be attracted to jobs that give high adrenaline surges. Of particular note is another aspect of Babiak's research that shows these people may get to the top but that , once there, they perform noticeably less well than their peers. This should not be surprising - business is a collective activity that calls for social skills far beyond a mere ability to manipulate others.

Perhaps none of this should be too much a of a surprise. Many of us will have come across such people; manipulative, bullying charmers who, you feel, would sacrifice anyone to their ambition, whether friend or foe. And yes, I have felt they talked the talk but actually lacked the substance to perform in that top job.

What implications for corporate governance? I think this raises serious questions for those people who believe that rules and codes, or even laws, will control corporate governance on their own. If one or more senior people in a corporation is driven to take risks and seek thrills whilst having no moral scruples about harming others then will they not simply ignore those rules if they can? And the more precise you make the rules, to strengthen them, the more chinks appear, through which the determined can wriggle. You have to have the rules, but more important, you have to have the collective ethos that, like a net, holds the errant individual tightly in its strands. To continue the analogy, if the individual can cut one of the strands of the net then the net is weakened but it will still hold him unless he can cut many strands. So the real constraint comes from shared values across the organisation, where people will not be bullied into doing things that are patently contrary to those well-communicated values and the constraint comes from individual ethical behaviour - which is shared values at a society level.

Wednesday, 24 August 2011

Financial Times Briefings: Corporate Governance

My book on UK corporate governance is finally published.
ISBN-10: 0273745972

"Corporate governance describes the systems, procedures and behaviours by which an organisation is directed and controlled."

The book is designed as a quick, practical and accessible guide to what you need to know about UK corporate governance. It describes the basis of law and how voluntary codes, backed by a "comply or explain regime", were encouraged as government took fright over the effect of corporate scandals on capital markets. Inevitable accretions of bureaucracy have led to the voluntary approach being partly subsumed into law and describes how this trend is likely to continue under the influence of EU pressures to unify national practices.

The book covers the responsibilities of directors and boards and how the latter should be organised and managed. It also addresses the practicalities of how to measure, manage, discuss and justify corporate governance.

However, rules are not enough – both corporate scandals and anecdotal evidence suggest that behaviours are critical to good governance. Indeed too much legislation is counterproductive, turning into a box ticking exercise rather than something people really engage with. For the ill intentioned those laws and regulations merely provide neat targets for side-stepping and proving that their behaviour did not quite fit the definitions givem. Rules and codes, together with the prevailing climate of opinion can encourage appropriate behaviours and ensure the quality of the ‘Boardroom Conversation.’ But  if people think they can get away with sliding around the definitions while ticking the boxes then many of them so; that climate of opinion is critical because it can discourage behaviour that falls just outside the definitions but that business partners believe is beyond the pale.

Furthermore, governance extends beyond the boardroom door. The blowout at BP’s Deepwater oil rig and GSK’s product quality failings at its Costa Rica drug manufacturing plant occurred despite compliance processes and safety officers and reams of risk assessments and governance procedures in annual reports. The behaviour of subordinates is also the responsibility of the board and an integral part of their governance duties – how do they make their policies stick?

The book emphasises that corporate governance applies as much to private as to listed companies as well as to a range of public bodies and not-for profit organisations. Good corporate governance contributes to business success, to successful fundraising and to dealing with business partners. It balances the needs and rights of different interest groups. It constrains the overmighty chief executive, chairman or shareholder to consider other stakeholders, appropriate levels of risk and to follow fair and transparent processes. It should reduce the incidence of corporate disaster as much as corporate fraud – better board structures and approach would surely have increased the chances of GEC avoiding policies that led inexorably to the company’s implosion? 

Key chapter headings include;

PART 1 – In Brief   

1          The executive prĂ©cis:

2          What is it? What do I need to know?  Key terms/ concepts

The Background, Corporate Culture, Creative Accounting, Individual Behaviour, The legal structure, Current UK developments, Voluntary Codes or Legislation? The International Picture – EU, The Sarbanes Oxley Act etc

2.1            What is it for?  
2.2            Who is it for?  
2.3             Objectives

3.         Why do it? Risks/ Rewards
Compliance, Stakeholder demands, Corporate effectiveness, Public and Employee Relations, The costs, risks and rewards of good governance, Roes it work? Reasons for Corporate Social Responsibility

4.         Who’s doing it? Who has done it?   
What do success and failure look like?
PART 2     In Practice          

5.         How to do it

Role and Duties of Directors, The role of the Board, Integrity and Values, Shareholder rights, The Role of Markets      

6.                  How to manage it
7.                  How to measure it
8.                  The business case for corporate governance

9.                  How to talk about corporate governance      

PART 3 - Intervention

Executive intervention, Internal communication, Delegated Authority, Risk Management, Whistleblowing, When is my intervention needed? What questions should I ask, and who should I ask?   What are the decisions I need to make? What levers should I pull?            How do we know when we’ve succeeded or failed? 

PART 4 – Other Resources

websites, books, courses, consultants

Tuesday, 23 August 2011

Do directors of private companies have a duty to declare insider knowledge when puchasing shares?

Yesterday The Times reported on the settlement of a court case involving former shareholders in Uswitch who alleged that the Marquess of Milford Haven induced them to sell their shares, at an undervalue, to a company that they did not know was connected to him. Shortly afterwards the business was sold in its entirety for over £200m to a US company at a price per share some ten times what they had received.

The outline of the allegations points to an anomally in UK company law. For a company whose shares are publicly traded on an exchange, the directors are obliged by the Financial Services and Markets Act to disclose information about their share dealing and to make full disclosure of relevant information to shareholders through the regulatory news services. But this legislation does not apply to private companies. Shareholders in these businesses can only sue for deception or misrepresentation if they feel they have been wronged.

In another example, a friend of mine is a shareholder in a private company. After some years the shareholders as a whole appointed an outsider as chairman who, over a period, bought shares from individuals and became the largest individual shareholder. During this period there were expressions of interest from a foreign company in buying the business, though this has not yet come to anything. My friend thinks the chairman is very capable and has done a good job. There is no implication that he has done anything morally wrong. But UK company law offers very little protection if he had used inside information to buy shares at an undervalue. In this case, at least, the sellers would have known they were selling to an insider but would they have imagined that protections against insider dealing applied to them? Insider dealing is an offence defined in relation only to quoted companies not to private ones.

It seems to me that larger private companies which allow their shares to be traded should produce, at least, a code of behaviour for directors and other executive shareholders. If it were possible to put something stronger in place through a binding shareholder agreement that would be better. If a satisfactory way could be found to extend the law to private companies then that would be better still.

Thursday, 18 August 2011

Transparency International calls on FIFA to improve governance

Article by Aarti Maharaj in Corporate Secretary reports that Transparency International, the corruption campaigning and monitoring group, has produced a report that suggests, among other things, that a group of independent outsiders should oversee the current review.
 “FIFA says it wants to reform, but successive bribery scandals have left public trust in it at an all-time low. Working with an oversight group – taking its advice, giving it access, letting it participate in investigations – will show whether there is going to be real change. The process has to start now,” said Sylvia Schenk, senior advisor on sport to TI.

That certainly suggests a pretty low degree of trust in Fifa and its internal processes...probably well deserved.

Tuesday, 16 August 2011

Peter Day's radio 4 programme on corporate governance

If you missed it then it is worth listening to this programme on corporate governance. It covers too many issues too superficially and seeks too many easy soundbites but it assembled a group of mostly impressive and interesting people to provide those soundbites. And, Peter Day actually asks some very good questions. And, by the way, most of those issues are really important.

FTSE 100 CEO pay unrelated to performance

I have written before, quoting Chris Bones and Sir Paul Judge, about how directors have, over a number of years, captured increasingly huge pay packages that bear no relation to their own or their companies' performance. Further evidence is provided by the Manifest and MM&K Total Remuneration Survey 2011, quoted in Tricker and Mallin's blog. 

They report that "median FTSE100 CEO remuneration increased by 32% to £3.5million in 2010 compared to 2009, whilst the FTSE100 index only rose 9% over the same period." I am prepared to bet that the falling stock market and falling corporate profits in 2011 will not show up in reduced remuneration!

Tuesday, 9 August 2011

How does the board ensure its policies are carried out?

I started an online discussion on this topic on a forum for governance professionals and was startled by the responses. They read as if they resulted from quoting a particularly unimaginative textbook, referring to committees, escalation procedures, frameworks, second and third lines of defence, a performance management dashboard; oh, and before I forget, reminding each board member of their duties.

Now the forum members are meant to be people who work in the area of governance, probably many are company secretaries or internal auditors - and not a clue. Not just no clue about the answers - which are difficult - but actually no clue about the questions either: they just did not understand the problem. There are two distinct sets of issues connected with making sure that board policies are actually being implemented. The first is where the board policies are communicated but at some point in the process, by the time they get to the operational front-line they are changed or blocked or just not carried out. The executive directors probably believe the policies are being observed but there is a disconnection in the line of command and they are not. The second issue is where the problem starts at board level. Different executive directors may be in conflict and battling for resources and influence or there may be disagreement about the policy - in the latter case it is communicated and implemented with a lack of enthusiasm, which prevents it from working - in the former case there is deliberate obstruction. In any event the problem is not rules, procedures, mechanisms, frameworks etcetera: it is behaviours.

Even in traditional command-and-control organisations it was a myth that the leader would give an instruction and that it would be passed accurately down the chain of command and carried out diligently and immediately at the operational level. There were endless opportunities to obstruct or reinterpret direct instructions. In more modern, more flexible organisations there are infinitely more ways to delay or ignore and, perhaps counter-intuitively it is the network of frameworks and procedures that helps those who want to obstruct. Whenever there is a precise regulation there is an opportunity to misinterpret it. I believe that the answer to the problem I set lies in working to change behaviours. One respondent to the governance forum did come up with a solution that showed understanding of the problem. He proposed making executive board members accountable for particular board policies and having this tied to their remuneration. So if X is tasked with carrying out a policy and it can be shown that has not been done effectively then X is paid less. This could apply not just to one person but to a management team.

Unfortunately this is only half of the solution because it may influence those at the top but does not address the disconnection that can exist between policy makers and operational management. Merely punishing those at the top for not making something happen does not actually do anything directly to make it happen. It may sound a little vague, but the key to good management and effective governance is shared vision, shared values and shared understanding across the organisation. When the board makes sure that their vision and values are clearly communicated and that their goals and strategies are too, then that is a critical first step to ensuring that all policies are carried out. The next step is to make sure they are shared as well - so that you don't need to bombard people with detailed instructions because they will use their initiative within prescribed boundaries and it is clear to them what they should do and they are committed to doing it. You do this through excellent communication and through the reward system and through development of line managers to do what line managers are meant to do: to direct and develop their staff and to communicate effectively with them and to feed information back up the line. So the result is that good governance is not a system that is bolted on to an organisation like an external skeleton - if it is to work it must be part of the DNA of the organisation.

Monday, 25 July 2011

SFO uses civil recovery under Proceeds of Crime Act in corruption case

There have been reports over the weekend of Macmillan publishers agreeing an £11m settlement with the Serious Fraud Office in relation to corrupt practices in Africa to win contracts and the SFO has released a statement.

Two interesting points emerge from this;
  • Firstly, that we focus too much on the new Bribery Act when there is other existing legislation that is used to address problems of corporate bribery. Civil action using section 5 of the Proceeds of Crime Act provides wide powers for restitution and can be much quicker, cheaper, easier route for the authorities to pursue. The standard of proof is also lower - civil actions requiring a 'balance of probabilities'. As I discussed in a post just a few days ago, Willis have been prosecuted under the Financial Services and Markets Act.
  • Secondly that the SFO and FSA seem to be very active in steps to prosecute bribery and corruption overseas. This case is only one of several to have been dealt with recently.
While I have blogged about the feeding frenzy of corporate advisers preceeding the introduction of the Bribery Act this month, nonetheless companies should be reviewing their procedures for preventing corrupt practices. My caveat was that it is unnecessary to spend large sums with advisers who, along with the rest of us, can have no idea what the courts will deem to be adequate precautions. Following the Ministry of Justice guidance would seem to be sufficient and excessive bureaucracy would seem...excessive...and may not be effective. This is a case for intelligent design.

The first step is risk assessment; the second clear statements (commitment and training) from company boards on acceptable behaviour; the third due diligence on business partners, the fourth accounting control of the flow of money - so you know who receives payment and for what - even when routed through third parties - this also includes monitoring of procedures.

Thursday, 21 July 2011

FSA fines Willis Ltd nearly £7m for failings in anti-bribery controls

We may have focused so much attention on the UK Bribery Act that we forget there are other regimes and legislation that cover this area.

The FSA has announced its action in respect of system failures that raised the risk of corruption and bribery. In particular...

The FSA investigation found that, up until August 2008, Willis Limited failed to:
  • ensure that it established and recorded an adequate commercial rationale to support its payments to overseas third parties;
  • ensure that adequate due diligence was carried out on overseas third parties to evaluate the risk involved in doing business with them; and
  • adequately review its relationships on a regular basis to confirm whether it was still necessary and appropriate for Willis Limited to continue with the relationship.
These failures contributed to a weak control environment surrounding payments to overseas third parties and gave rise to an unacceptable risk that these payments could be used for corrupt purposes, including paying bribes.

So although Willis found £227k of suspicious payments to Egypt and Russia no actual bribery was proven - this was a punishment for failing to take measures to control the use of payments through third parties.

This action was taken under provisions of the Financial Services and Markets Act.

An interesting sentence at the end of a report in the Washington Post extends the likely scope of such FSA action..

The agency said last month it is opening a review into whether investment banks have systems and controls in place to prevent their employees from paying bribes to win business.

That should prove interesting

Tuesday, 19 July 2011

Rupert Murdoch, News Corporation head testifies to British MP's

An interesting facet of Murdoch's testimony was his insistence that the News of the World is a very small part of News Corporation's interests: less than 1%. Given this, he would not have expected to be directly involved in the issues MP's were grilling him about. Actually the word 'grilling' is a little misplaced - it reminds me of Denis Healey's riposte, that it is "like being savaged by a dead sheep". The one line of questioning that was interesting regarded who, in management, asked what and when about the dossier of emails sent to lawyers - which constituted the central beam of News International's investigation to see whether the hacking went wider than the Royal Correspondent convicted in 2007. But more of that later.

Actually, it does not seem unreasonable that the chairman of the ultimate holding company should not have been hands on. The person at the top of a very big business cannot deal with the minutiae of every subsidiary - it has to be delegated - that is proper corporate governance. What is a little more surprising is to be unaware of the detail once the potential damage to the overall business becomes apparent. Surely, then good corporate governance demands that not just the chairman but also the main board should be aware of the detail. The local management should normally be left in charge, unless it appears they are taking bad decisions or cannot cope, but there should be written as well as verbal reports to the main board. And I would have thought that once this member of staff had been convicted then there existed the risk that the scandal could spread: that there could be contagion to other parts of the business.

What seems to me curious corporate governance is that an investigation was instituted - the main focus of which was communications by email from selected journalists at News of the World - and nobody from senior management seemed able to tell MPs who had chosen which journalists' emails should be looked at, how they were selected or what was the brief to the lawyers who reviewed them; not the regional head (James Murdoch), nor the chief executive of News International (Rebekah Brooks) nor the editor of the News of the World (Colin Myler). And nobody other than the external lawyers seems to have read them until the past few weeks.

Latterly those emails have been reviewed, as part of a renewed internal investigation and the results thought serious enough for the dossier to be handed to police.

Even a small part of a sprawling business empire can cause serious problems that are disproportionate to its profit earning share. When that risk becomes apparent then good corporate governance demands that the main board asks for and is given more than mere reassurance but is given the detail upon which to base an assessment of whether the risks are being managed appropriately. According to Rupert Murdoch that has not happened and he is still personally unaware of some of the detail. Even James Murdoch and Rebekah Brooks seem to have a wide range of unawareness of detail.

Monday, 18 July 2011

Association of British Insurers warns over poor governance at Cable and Wireless

Cable and Wireless share price has dropped 44% in the year since demerging into two companies - 'to release shareholder value'.

However the Association of British Insurers, representing investors holding some 20% of the share value of the London Stock Exchange, is not amused. Although possibly welcoming the ejection of the chief executive who has presided over this decline, they are outraged to find that his replacement is to be John Pluthero, the chairman, who may combine the two roles. This has earned the company one of their 'amber top' warnings.

They are also outraged by the decision to award shares to senior executives based on a four times multiple of salary (apparently, since reduced to three times), and to alter the performance targets in the light of 'turbulent markets'. Issuing executive share deals just after a sudden share price drop risks giving them a huge payout for pedestrian performance. Indeed, The Guardian reports that Pluthero has collected almost £15m since joining the company in 2005 - although shareholder value has declined 11%! Nice work if you can get it.

Sir Paul Stephenson resigns as Metropolitan Police Commissioner

What does this have to do with corporate governance? My answer is that it has plenty of lessons for us.

Newspapers have reported that Sir Paul Stephenson employed Neil Wallis, formerly deputy editor the News of the World, as a PR consultant. Unfortunately this man has subsequently been arrested in connection with the News of the World phone hacking scandal. The implication is that there was an improper relationship that could have affected judgements in relation to the investigation or that it was a reward for past favours. Just an hour ago I wrote, "It seems unlikely that either of these is true. After all, the most skilled advisers on dealing with the press are likely to be former senior members of the press." However, I have since read the New York Times article that says that Wallis was hired specifically to advise on phone hacking matters. If that is true then it changes everything and provides evidence for an improper relationship between police and the press.

A second report revealed that Sir Paul had stayed free of charge at an expensive 'health farm' following surgery last year and that this same Wallis was PR adviser to that business. However, it is also said that Stephenson was a personal friend of the owner. The Wallis connection is therefore a red herring. The more significant question is whether a senior police officer should be accepting large gifts from anyone, even a close friend? I think the answer is a clear negative and I was surprised to read that there is a register for police officers to report such gifts - gifts that should not be accepted in the first place.

It must be good practice for directors and senior executives also to report gifts and for their companies to publish a clear policy on what is acceptable and what is not. This is particularly important since the UK's Bribery Act came into force this month. Gifts, including hospitality, are generally given to business acquaintances in order to influence their decisions: why else would they be given? Since an invitation to a night out at the opera and dinner - or to a major sporting occasion - is likely to cost more than £1,000 the sums involved are not trivial. It is a difficult argument but I can accept that some level of hospitality oils the cogs of business without creating an improper influence. The recipient of 'low level' hospitality still feels able to cancel a contract or negotiate hard for lower prices. But it is wise practice for companies to maintain a register of all hospitality and gifts received and given.

But it can never be appropriate for a police commissioner who earns £276,000 per annum to accept a favour worth some £12,000 from anyone, even a close friend. On the one hand he could afford to pay for himself whilst on the other hand it is significant favour.

It is important to remember that we are not the judge in our own case; and for Sir Paul to claim his integrity is untarnished is mistaken because that judgement is for others to make.

Tuesday, 12 July 2011

Corporate governance at News International

The news media and blogosphere is full of the goings on at the News of the World, where there is evidence of journalists writing stories based on unlawful hacking into the telephone messages of private individuals. Subsequently there has been evidence emerging of money being paid to police officers for information that subsequently has formed the basis of articles.

I will focus on just a very small area of this wide ranging scandal, an area that has clear corporate governance lessons. That is the response of News International to developments. In January 2007 the royal reporter of News of the World, Clive Goodman, was sentenced to four months in prison for procuring phone hacking by a private investigator, who was also jailed. The Sunday Times (also part of the News International empire) reported last Sunday that "The case triggered a thorough review at News International" But what follows is interesting, the article reports that "Colin Myler, who replaced Coulson as editor at News of the World was tasked with the enquiry".

The board, in such circumstances, will want to make sure that they incur no personal legal liabilities through inaction: for example, The Regulation of Investigatory Powers Act 2000 covers the interception of mail or telephone conversations and provides for directors of offending companies to be, themselves, liable to criminal prosecution in the event of consent, connivance or neglect. The board will also want to protect the value of their company from reputational damage or the consequences of further prosecution. However, if you are a director, you may face a dilemma; suppose you know or suspect that such practices are widespread industry practice? In such circumstances you can be pretty confident that a proper investigation will damage the business by its revelations but if you do not investigate properly then you face possible personal liability and the risk that the damage will be worse if it is revealed by someone else or by legal processes. If you suspect that all outcomes will be bad, how do you determine which is least bad?

Now, as a director of News of the World, if you were serious about investigating this matter, would you appoint your new editor as the man in charge of the enquiry? Colin Myler is a very experienced newspaper editor. Of all people he would know about industry practice in the tabloid press.

At this point we can jump to the outcomes, of which there are two;
  • Firstly, in 2009, Myler and Crone (head of legal affairs at NoW) assured the culture, media and sport parliamentary sub committee that the investigation had not revealed any wrongdoing by other reporters.
  • Secondly there is the report itself, which has apparently now been handed to police.

The Sunday Times quotes a source about this report
"It is a reasonably decent investigation and either they were idiots for not having acted on it or they deliberately didn't"..."They got very strong indications of all sorts of dodgy behaviour. It revealed [possible] police payments and indicated enough about phone hacking to be of serious concern."
Myler and Crone now claim they had not read the final report they had commissioned and, apparently, overseen or the data attached but relied upon an audit carried out by external lawyers. That beggars belief. There is this really serious matter you have been tasked with looking into and you don't want to know the detailed findings? You have no conversations with the people you had delegated to carry out the work and nor would you stay up all night poring over the pages?

But over and above that, what about the board and their governance responsibilities: was this report an agenda item at board meetings; did the board rely upon a brief audit letter from outside lawyers that reported on the report and if so, why? What about individual directors, did none of them want to see the report itself? If these matters of board responsibility are ever pursued in court I find it hard to imagine that a court would conclude the board had been other than negligent if they really did not see the original report of their internal investigation into this serious matter.

Sunday, 10 July 2011

The regulator's role in the ENRC Fiasco

Back from holiday and catching up. One of the first things I saw was an excellent article in the FT by John Plender. Unfortunately, it is behind their paywall, but the FT allows you to sign up at no cost to access a limited number of articles.

To recap, ENRC, a Kazakhstan mining company  listed just over 18% of its shares in 2007 and promptly joined the FTSE 100 index. This means that UK index funds have to hold its shares.  Plender points out that when it was allowed derogation from normal listing rules demanding 25% of shares be floated this was
"Far from being unique this was symptomatic of the pre-crisis “light touch” regulatory approach that was designed to enhance London’s position as an international financial centre." 
A number of similar mining companies listed at that time, all with a small number of wealthy controlling shareholders and with a history of related party transactions. How did the London Stock Exchange and the Financial Services Authority deal with these additional risks? Plender writes...
"To address these risks the LSE and the FSA, which acts as the listing authority in the UK, have put their faith in relationship agreements with controlling shareholders and in independent non-executives. These directors have often been highly experienced business people, but most have had little knowledge of mining. Their fees tend to be well above average, which does little to reinforce their independence. Against that background the ENRC fiasco demonstrates, among other things, that the UK approach to governance is not designed for a system in which controlling shareholders call the shots. It is structured to address the problems of dispersed ownership."
Whilst well expressed, this is too kind. The LSE was desperate for the business and bent its rules while the FSA was just asleep on the job, unless they were a lapdog for the LSE, which is scarcely less demeaning.

One of the key points of good corporate governance is that the rules and regulations need to be policed by regulators. I would go further and say that the regulators need also to apply judgement. The FSA surely has a duty to protect investors and that should have included wondering about the level of governance risk attached to these mining companies. Old City practices were opaque and decisions were often made by unaccountable individuals in smoke filled rooms. Nonetheless, I think that in the past these companies would not have been allowed to list in London without stronger safeguards for investors.

Plender finishes by saying

"The low standard of governance among foreign owned mining companies is not just a potential threat to investors. If valuations in the wider stock market become tainted by a governance discount as a result, the cost of capital to UK companies will rise. ENRC should never have been allowed in and nor, in my view, should the others. But since they are here, pension fund trustees who run indexed portfolios should consider asking their managers to exclude these companies from the index."
 Which is true but insufficient. The government really needs to get a grip on the FSA.

Wednesday, 15 June 2011

Tokyo Electric Power (TEPCO) and the nuclear plant at Fukushima Daiichi

There was a very interesting post by Bob Tricker back in April that addresses corporate governance issues behind the nuclear release at Fukushima. It is too long to reproduce but here is the link. The issues are, on the one hand, culturally specific to a Japan which is deferential to authority, avoids confrontation and manages by consensus. However it holds some broader lessons for all of us.

It appears that TEPCO has some record of safety violations and delaying the release of information, which may be putting it kindly, to shareholders, regulators and the public. It also has a large board of directors with only two non-executive directors - one of whom is a connected party. It is therefore a very large, complex company which has no real mechanism for constructively challenging the management team. You would imagine that a country such as Japan, which displays the cultural characteristics in business referred to above, has an even greater need than Western countries for some external, constructive challenges to groupthink. TEPCO and the 2009 crisis at Toyota demonstrate that companies that do not seek out challenges to their thinking deliver poor responses to crisis. Whether they are more likely to encounter a crisis in the first place is a more complex issue.

You could argue that I am being unfair and could point to BP's Deepwater oil spill as a counter-example. It seems that BP did not manage safety as well as it might, despite having genuinely non-executive directors. Well, I would not argue that the mechanism works infallibly to counter all business problems. I would argue that it is a mechanism that ought to respond well to crisis as the non-executives seek to understand what has happened. It also has a better chance of creating a climate of enquiry before disaster strikes.

Sunday, 12 June 2011

Some complexities of Corporate Social Responsibility

I can be a bit of a sceptic about 'green' and CSR issues because, although these are important and are undoubtedly part of the corporate governance discourse, they are often just a bandwagon of muddled thinking.

An article in the Times on 10 June illustrates this.
"Electric cars could produce higher emissions over their lifetimes than petrol equivalents because of the energy consumed in making their batteries, a study has found."
Unfortunately, the article is behind a paywall but here's the reference anyway. Quoting from a report commissioned by the government funded Low Carbon Vehicle Partnership, it says that electric cars actually give rise to more CO2 emission than petrol and diesel cars if you take into account their production - and particularly production of batteries - and disposal. What this illustrates is not that nothing should be done about global warming but that CSR issues can be fiendishly complex. Just jumping on any old passing bandwagon can be a mistake, so political and business leaders should take a cautious view and should try to avoid being steamrollered into knee-jerk responses to environmental and 'sustainability' lobby groups. In particular, calls for corporate reporting on environmental issues - an issue promoted by accountancy firms which see large fee opportunities - should be approached with caution. You can easily spend time and money reporting on your firm's CO2 use only to find it is hugely misleading. Of course you may not care about that if it was only a public relations exercise in the first place; but if you were genuinely trying to be open then it may be a  bit disappointing.

The main thrust of the press release that launched the report was to encourage people to take a 'whole life' view of vehicles rather than just focusing on basic petrol/diesel consumption. Interestingly, the Times seems to have had access to the report itself (which I can't find posted on the web), which seems to make electric cars seem even less environmentally friendly than the press release itself revealed.

Thursday, 9 June 2011

Eurasian Natural Resources Corporation ejects independent directors

It is not really such a surprise that the controlling shareholders of this FTSE 100 mining company have just exercised their control and ejected two of the non-executive directors. What is a surprise is that the London Stock Exchange decided to admit the company to its lists in the first place. It is also a surprise that the shares were then included in the FTSE 100, automatically obliging tracker funds to invest in them.

The governance of this company was always questionable. Consider that the business only has some 18% of its shares floated, the rest being mainly controlled by three Kazakh oligarchs, the government of Kazakhstan and another Kazakh company. Kazakhstan, it may be noted, is a dictatorship under president Nazarbayev. To add colour to this, it is the sort of country where a Uighur journalist, having fled to it across the border from China, seeking refuge after the ethnic troubles there, and having been designated a refugee by the UNHCR, but has just been shipped back to China by the Kazakhstan government although other countries had offered him refuge.

Anyway, City grandees were appointed as independent directors to ENRC, when it was floated in London, to demonstrate good governance. They included Sir Richard Sykes, former head of GlaxoSmithKline and Sir Paul Judge, former head of Premier Foods.

To be fair, those who bought shares in the company would have known what sort of business they were investing in. They knew they were a minority in a company dominated by a very small group of shareholders and the chairman, Johannes Sittard, was known to be a long standing business associate of theirs. They knew that Kazakhstan is a dictatorship and a reasonable person might have guessed that the key decisions would, in reality, be made amongst this small group of people despite the fact that they do not directly have seats on the board.

Surely those City grandees would also have spotted all this. Apparently that other investor in African natural resources, from a bygone age, Tiny Rowland, described non-executive directors as ' a bauble on a Christmas tree' - maybe the world has not changed so much. But why did these heavyweight directors lend their names to this company when their function was clearly just pr? Their careers have been impressive; they have often said impressive and sensible things in the past; they are already wealthy men, they didn't need the money, why prostitute themselves? (Though Sykes remuneration, at £250,000 seems extraordinarily high for a non-exec). I have remarked in a previous post that the essence of good governance often comes down to integrity.

A few months ago ENRC was involved in a much debated transaction, buying a mine in the Congo that had been expropriated by the government. This appeared to smell of receiving stolen goods and is now subject to litigation from the previous owners. In that instance Sykes was a vociferous defender of the company he now recommends shareholders to disinvest from. He is also now quoted as using the phrase 'mad oligarchs' whilst the other ousted director, Ken Olisa, is reported to have used the phrase 'more soviet than City'. I suppose a late conversion is better than no conversion.

This whole sorry affair raises questions about integrity, about the judgement of people running the London Stock Exchange and about the regulatory regime under which this could occur. In the 'bad old days' of chummy, clubbable merchant banking types before Big Bang a handful of grandees would have had a chat and decided that there was a fishy smell about an outfit such as ENRC and it would have been blackballed, regardless of the potential for earning nice fees.

By the way, the shares have done quite nicely - up to over 800p from a flotation price of 540p in 2007 - though 29% down this year.

Wednesday, 8 June 2011

Directors personal responsibility

In the wake of the Berkshire Hathaway affair, where David Sokol, a senior executive, recommended a bid for Lubrizol, a company in which he had recently bought shares, I have been thinking more about personal responsibility. I strongly believe that rules and regulations matter. After all, I have a vested interest, with a forthcoming book on UK corporate governance (Financial Times Briefings: Corporate Governance). But rules can only provide a framework and a minimum standard of behaviour - they can never cover every situation. And only an ethical approach can fill in the gaps that are not covered by this framework.

Driving from the airport this morning I heard two juxtaposed items on the radio that illustrate this. The first piece reported on a football match in Chechnya to celebrate the opening of a new football stadium in the capital, Grozny. The local side, bizzarely, included Ramzan Kadyrov, the country's president, as striker and he scored a hattrick in his side's victory over an international all-star's side. But it was this team of former international players that interested me. It included two former England internationals, Robbie Fowler and Steve McManaman, who were interviewed. Both insisted they were not interested in politics, just in playing football. Yet this was not just an ordinary football game. All its unusual features proclaimed this fact. The presence on one team of the country's dictator, a man accused of personal involvement in murder and torture, whose opponents, as well as local  journalists and human rights activists, have a habit of being killed, proclaims that this was not just a football match. This was clearly not an instance where politics relates to polite political debate but an instance where the event was an integral part of a plan to confer legitimacy on a much harsher political reality.

The other item was a report on UK banks misselling of Payment Protection Insurance that was meant to protect people who were unable to repay loans. It seems clear that at some level of the hierarchy within not one but a numberof banks a decision was taken to encourage and incentivise staff to sell of these instruments in reckless disregard of whether they were suitable to the customer. I am sure that staff were not actually told to sell this insurance to everyone, whether appropriate or not. However, some people within the organisations must have realised there was an absence of the controls that would ensure the insurance was only sold where it was appropriate. They were either reckless or dishonest or were unable to make themselves heard within the management system: which would probably point to someone else having suppressed their concerns.

Both of these stories point to the need for individuals to take responsibility for their actions. Whether it is footballing whores or banking executive whores it is always important to accept personal responsibility. It is easy to recognise the thirty pieces of silver you are being paid but, usually, it is also easy to recognise the reality of what you are being asked to do in return. The biblical story of Cain and Abel reports Cain saying "Am I my brother's keeper?" and it carries two lessons. The obvious one is that Cain was involved in a cover up: the more difficult one is that, yes, you do have responsibilities for your brother.

At the heart of corporate governance we find integrity and ethical behaviour and it is actually not that hard to spot the right thing to do. What is sometimes hard is to turn away the thirty pieces of silver but it is down to each of us to behave properly and to speak up when others do not.

Thursday, 2 June 2011

The FIFA bribery scandal: and Sepp Blatter

Well, how can I not write something about this spectacular news story. Even though it relates to a not-for-profit, global sports body it has so much to teach us about corporations.

To summarise the key facts; evidence is published, including some from internal whistleblowers, that seems to confirm what many people have talked about for years about FIFA - many people connected with it are corrupt and the right to stage the World Cup every four years seems to be bought and sold. Meanwhile the chap who has been president of the organisation whilst all this widely publicised misconduct has been going on puts himself forward as a reform candidate and is re-elected unopposed.

So, to the lessons;
  • Vested interests rule. If an organisation is doing well then there is little stomach for doing anything about a bit of corruption. FIFA has grown spectacularly under Sepp Blatter's stewardship, with annual income more than doubling since 2003. Over the four year reporting period to 2010 they have invested nearly $800m in football development around the world, being channelled largely through member associations. 
  • Wrongdoing thrives in organisations that operate under a single dominant personality. It derives from an absence of checks and balances and from all decision making being channelled through that individual. This person, to preserve power, will be reluctant to act against the interests of political supporters almost regardless of what they may do. This is regardless of whether the individual is personally corrupt.
  • Publicity for wrongdoing does have an effect but only if it threatens the performance of the organisation. So, only when the bad publicity for FIFA grew to an extent to threaten the image of organisations that sponsor the World Cup did official denial that there was any problem turn into some limited action.
All the rest is detail. I could write about systems and procedures, and those do matter, but they will not be effective if there is a dominant individual operating under big vested interests who are tolerant of a bit of corruption. Sure, the proposal to award future venues for the World Cup through a vote of the 200-odd member organisations, will make it a little harder to bribe to a result than the present system where there are only 24 voters. The largesse will have to be spread more widely. But, on its own, that change will not be sufficient to root out corruption.

In order to have a reasonable hope of preventing wrongdoing, there have to be independent powers who are able and motivated to oversee and control the executive management of an organisation.

Bribery Act Panic (2) A consultants' feeding frenzy

Like the 'Bribery Act' the 'Health and Safety at Work etc Act' was broadly a good idea. Data from the Health and Safety Executive illustrates how injuries in the workplace have declined over the years and it is important to remember that many of these injuries were not just minor burns, cuts or bruised knees but will affect entire lives. So achieving significant success in reducing this suffering is neither trivial nor is it justly described as 'bureaucracy gone mad'.

However, there are some other consequences of a Health and Safety approach that are not quite so desirable. Search for 'shop accidents' on the web and see how many firms of lawyers are touting for business from customers injured whilst shopping. This is a case, almost literally, of 'ambulance chasing', yet the sheer number of adverts raises the suspicion that the promise of compensation may itself give rise to some of those injuries in supermarkets. Search also for H&S consultants and see how many people make a good living from giving advice in this area. The legislation does not demand the use of external consultants - you can write your own risk assessment and your own policies - yet it has become the default position for most organisations. It is now generally assumed that you need to employ an external consultant or you are pushed into it by your insurers (who may also provide the consultancy). This amounts to a huge extra 'tax' on employers. A relatively small retail organisation I know of is spending around 7% of annual profits on a consultant, in addition to the sums charged by their insurers for a consultancy programme.

The Bribery Act already seems destined to travel down a similar path. The lawyers and consultancy firms are running courses and offering their services in conducting risk assessments, devising policies, installing computerised systems, sending questionnaire's to staff and suppliers. As pointed out in my previous posting, we don't yet know how the law will be interpreted and enforced: the government has promised a commonsense approach to prosecutions. So, much of the panic and much of the consultancy is premature. Yet, as with Health and Safety, we are likely to find ourselves encumbered with superfluous costs and bureaucracy even though the basic objectives of the legislation are worthwhile.

Friday, 27 May 2011

Bribery Act Panic

There is a great deal of senseless panic being whipped up about the implications of the UK's new Bribery Act, that comes into force on 1 July 2011. An article by the City Editor, Chris Blackhurst, in yesterday's Evening Standard exemplifies the worst of the reporting. He talks about the harsh potential penalties and implies that these may be applied to 'gifts, hospitality and promotional expenditure'. Naturally the financial consultancies love this sort of stuff because it increases the demand for their conferences and courses on the subject and of course helps to sell lots of expensive consultancy - most of it a complete waste of money.

Oddly Blackhurst chose to ignore a previous article in his newspaper (11 March 2011) where UK Justice Secretary, Ken Clarke, is quoted saying;

a "common sense" approach would be used and stressed no actions could take place without approval by the Director of Public Prosecutions or the Serious Fraud Office - avoiding the "fatuous prosecutions" sometimes brought under health and safety law.
"Neither will bring silly prosecutions," he said, adding that it would be "completely safe" to take clients motor racing or to a football match.
"Taking customers to Twickenham is normal," said Mr Clarke - himself no stranger to corporate hospitality boxes. "But if you took them for a Caribbean cruise with the wife, that's different.
"It is normal business hospitality to get to know your customers better. No one is going to call that dishonest."
Now ok, I accept that at the end of that first article it quoted "Legal experts" as saying "Mr Clarke's assurances will not necessarily protect business figures from being jailed" and went on to quote someone from an outfit called "World-Check" saying "The guidance does not provide a defence to any of the new offences created." Except that World-Check and 'legal experts' may not be synonymous - and the former is a commercial company with a vested interest in panic.

I accept that the Evening Standard is right up to a point, the guidance notes from the Ministry of Justice as well as what the Justice Secretary has said could be ignored by the judges. But I don't think they will be. I think common sense will govern and I also think that the Director of Public Prosecutions - who can be replaced by the Justice Secretary - will act as a responsible gatekeeper and will prevent frivolous prosecutions.As a backstop this or a future government will simply amend the legislation if it does not work as intended. Reasonable corporate entertaining will not be caught within the ambit of the new law.

Whilst we await some case law to develop I urge company secretaries to read the MoJ guidance for themselves. But remember that if all this panic and selling frenzy from consultants and lawyers results in masses of unnecessary bureaucracy then that will set standards for courts to view as 'normal'. And you company secretaries and compliance chaps will have created the very rod that will be used to beat you.

Wednesday, 25 May 2011

Paying Executives for failure

There is an interesting reflection about golden handshakes for disgraced board members, by Chris MacDonald on his businessethicsblog. It was apparently sparked by news that Dominique Strauss-Kahn may be paid $250,000 severence by the IMF. But there is also a wider issue here about why failed as well as disgraced board members are often paid off handsomely and also why senior executives around the world have enjoyed such an explosion in their remuneration, capturing an increasing proportion of company income. Chris Bones, former dean of Henley Business School has written well about this.

I believe a substantial part of the explanation is an identification or affinity issue: ‘this guy is one-of-us, we must treat him as we would wish to be treated’. Identification is linked to an ‘oligarch’ problem, whereby, as well as competing with each other, senior politicians, business people and bureaucrats share a common tribal identity and common interests;

…years ago I took part in a business game conducted over a weekend between teams carrying out real projects for small sums of money contributed by the participants. It revealed that winning the game was easy if you cheated, as long as few others did. Getting on to the game’s ‘governing board’ and using that to increase our pay, as well as taking bribes from the teams, proved a winning strategy. By analogy, if the top guys in the world/business all help and cover for each other then, as a group, they achieve an optimum outcome. To achieve this does not require formal agreement or even informal discussion. I think it just happens through identification - it is why board remuneration committees pay their colleagues outrageous amounts that are unconnected with performance. It has nothing to do with an expectation that the beneficiaries will return the favour, although members of a remuneration committee who are still active in business will benefit from a general rise in the remuneration of senior executives and board members. It is much more to do with comparabilities (See business leader Paul Judge on this) where executive pay is compared with that of other companies who, at the next round, are then compared with your company - creating an upward spiral of pay, benefits and status.

Tuesday, 24 May 2011

The Board Challenge of the Dominique Strauss-Kahn Affair

Newspapers and blogs have been  full of reports on the Dominique Strauss-Kahn affair, but there is an important corporate governance aspect that has hardly been voiced. It has a wider application than this one incident or this one news-story; it is the question of what a board should do about reports of a sex-pest who occupies a senior role in their organisation.

DSK is clearly innocent until the result of his trial is known; but this is a general question. Has the board of the IMF done what it should? What, generally should boards do? They are at risk if they do nothing. They risk damage to their reputation but also possibly financial damage if they owe a duty of care to a complainant who can show that they knew or should have known what was going on and failed to act.

The IMF is a special case, where the Managing Director (DSK) is also chair of the board, reporting to a board of governors comprising nominees from shareholding countries – who do not get involved in detailed oversight of management processes. But what would be the situation in a corporate board? These situations may be rare but are not unknown. It is clear that responsibility falls on the chairman to institute an investigation whenever serious matters regarding the conduct of a director come to light. It is clear that any director who becomes aware of an issue should report it to the chairman. If the subject of concern is the chairman then a senior director should institute an investigation after having obtained the consent of the board. UK public companies have a Senior Independent Director who should perform this role. What should not happen is for these matters to be swept under the carpet. Waiting to see if they come before a court is not a good option.

This week’s reports that Fred Goodwin, late of RBS, had an affair with a senior colleague highlights another aspect of the same issue. Whilst it is common for partners to meet through work, an intimate relationship where one party is the chief executive, particularly in a bank, risks conflicts of interest that may affect financial probity. One is reminded of the affair of Paul Wolfowitz, president of the World Bank, who was accused of impropriety in having a relationship with someone who worked, indirectly, for him. One wonders whether this matter would have been pursued if its subject had not been a controversial figure who pursued controversial policies and had been appointed by an unpopular US president. But at the very least, such a relationship should be reported to the board so that they can monitor behaviour in the knowledge of the relationship. But generally I cannot believe that these work relationships are ever actually a secret – I recall working at a bank and stepping into the lift late one evening. The chief executive was also in the lift, going down to the basement car park with a young female lawyer who worked in the organisation. It may have been entirely innocent but I knew instantly that it wasn't. In reality board members pick up what is happening pretty quickly too but too often choose to ignore it. The likely outcome of doing nothing is not good and, in a world of Twitter and Facebook, will become less and less of a good option.

Sunday, 15 May 2011

Burson Marstellar contributes to corporate governance thinking

There were newspaper reports last week that Burson Marstellar had been retained by Facebook to get negative stories about Google into the press. 
Paul Cordasco, a spokesman for Burson-Marsteller, told the Guardian on Thursday that the assignment was "not at all standard operating procedure" and was against the company's policies. He added: "The assignment on those terms should have been declined."
Which raises a number of interesting governance questions;
  • at what level in the company was this assignment approved?
  • what are the company's policies and how are they communicated to staff? 
  • how does the company control what staff do?
Subsequently they added about the former journalists, who were trying to interest papers in these stories, that
The pair will receive receive extra "training" and Burson-Marsteller said it intends to redistribute its code of ethics to all employees in the wake of the scandal.
Could BM maybe publish this code of ethics as well as explaining what their systems are for controlling what their staff do? Because I find it very odd that a pr company does not have control systems that vet new assignments for issues such as appropriateness, ethics, conflicts of interest etc. If they don't then that is a huge governance issue because corporate governance is not just about boardroom behaviour but also about how the board communicates its values and controls how its people carry out company policy.

In the past BM has been accused of acting burnish the image of some pretty nasty African dictators and stepped back from such activities. In light of that is the company really saying that they don't have a system in place for new assignments to passed through an approval process?

Tuesday, 3 May 2011

David Sokol, Berkshire Hathaway and Integrity in Corporate Governance

Much has been written about David Sokol advising the Berkshire Hathaway board to acquire a company, called Lubrizol, in which he had recently bought shares. There has been much debate in public about whether he made sufficiently full disclosure and whether the board asked the appropriate questions. The point that emerges is that rules and procedures can only take you so far. In the end we rely upon personal integrity and a shared understanding of ethics.

The rules and procedures are just a starting point - any investment professional would ideally not invest on their personal account anyway. Sokol's earnings at Berkshire Hathaway are not made public but his role at MidAmerican, an 89% owned subsidiary, are reported to have brought him $24m over 3 years. One would guess that his other roles would have added substantially to this. His profit on Lubrizol was just $3m. I say 'just', that is a lot of money but surely, for someone on such a scale of earnings, it should be possible to abstain from personal investing without feeling poor?

I understand that the sort of executives sought by Berkshire Hathaway are natural dealers but surely...? But ok, suppose he could not resist...then, whatever the BH disclosure rules may be, surely if you advise a purchase of shares in a company where you hold shares you over-disclose: you detail what shares you bought, when you bought them and any surrounding circumstances such as advice to or even conversations with other people concerning the target company. You disclose who told you what that may have led you to buy shares. You cannot be too clean.

I understand that Sokol's lawyers claim he was not asked the right questions. Maybe not. But that ain't the point. My set of personal values says that no questions should have been necessary. Maybe this was just one of many investments and he forgot (actually it wasn't because he claims to make only a handful of trades each year). But if you are an investment adviser then, regardless of whether rules oblige you to do so, you should keep your own detailed register of interests so that nothing can be forgotten and so that all trades are reported to those you advise.

Like I said...rules are a starting point and then corporate governance is about personal integrity and a shared understanding of ethics.

Tuesday, 26 April 2011

Conflict of duties between nominee directors and company law

City AM reported on 20 April on a call to shareholders by Pensions Industry Research Consultancy (PIRC) to vote against the re-election of directors of Anglo-Swiss miner, Xstrata plc who are nominees of (soon to be floated) Glencore. They argue that these directors are not independent enough. This simply exemplifies a long-standing incongruity in company law and governance. The Companies Act 2006 makes clear that a director's duty is to the company they serve - so how can the nominee of another company and likely shareholder possibly be carrying out their duty? They are nominated in order to represent that other company, otherwise why would they be nominated? But this is blatantly incompatible with the legal position.

Wednesday, 20 April 2011

Appointment of Non-Executive Directors - how little has changed

Non-executive directors are in the front-line of corporate governance. A critical part of their role is to probe and challenge the executive directors - to hold them to account and to apply common sense and specialist expertise to test the appropriateness of their strategies.

The Higgs Report into the role and effectiveness of non-executive directors and the Tyson Report on their recruitment and development, both published in 2003, addressed issues of board composition. The latter, in particular, talked about the importance of board diversity to better decision making. In this it echoed the views of others, such as Tomorrow's Company. It talked about things such as defining skills or perspectives that are lacking in the board and going out and recruiting against that brief, It talked about being prepared to recruit from people who possess the right skills and qualities but who may have worked below board-level in their careers or have worked as consultants or advisers to businesses.

So have things changed with the passage of eight years and in light of the increased focus on corporate governance? Not a bit of it. British boards still have very few women but they also have very few of anything other than British, white, middle class, heterosexual men who share a very limited background and have all pursued very similar career paths. I know someone who is exploring the possibility of taking on one or more NED positions and she has been told by headhunters that, in reality, very few appointments result from search assignments. Companies don't want to pay. Just as Tyson reported in 2003, over half of appointments result from a tap on the shoulder by someone you know. Another person I know, who is looking for an NED role finds that his lack of previous main board experience is a huge impediment; this despite having served as a divisional MD for a large quoted company.

If non-executive directors really are important - and I believe they are - then this lack of diversity and lack of change is a real problem. I don't have a solution. I don't think legislation or regulation is appropriate but cannot think how we combat this damaging rigidity in our economic and social fabric. Tyson suggested measuring and reporting board background and composition on the basis that people manage what is measured. I am not sure that would work either but it is surely worth a go - however nothing has happened in this respect in eight years. Any ideas?

Monday, 18 April 2011

Shareholder rebels over executive pay

I would link this post to the headline in the Sunday Times, but it is hidden behind a paywall. The article about Standard Life, the biggest sharteholder in Rio Tinto, criticising "the mining giant for handing bosses generous rewards for hitting 'unchallenging' targets. It follows 41% of votes going against last year's remuneration report. The issue raises some interesting questions;

  • Should shareholder votes on the remuneration committee's report be binding instead of just advisory?
  • Should public companies treat these expressions of shareholder dismay rather more seriously?
  • Does the lack of board responsiveness itself point to serious governance issues? For example are the non-executive directors actually doing their job or are they merely cheerleaders for the board?

As time passes and we see more of this, I suspect there will be a growing consensus for reform. The big problem is that shareholders will rarely vote against the reappointment of directors. By the time a company is performing badly enough to warrant that, the shareholders simply sell and leave a takeover to institute reform. However that discipline does not help when a company is performing reasonably well, yet shareholders are unhappy about outrageous remuneration packages. What is needed is a mechanism that produces more active non-executive directors who are not all part of the club who vote each other outrageous remuneration. It is not even always that directors sit on each other's boards or are personal friends. They just have similar backgrounds and similar interests and believe that high remuneration for pedestrian performance is ok because that is the deal they have themselves received in their day jobs.

This is an argument for boardroom diversity

Friday, 15 April 2011

Financial Advisers in the Corporate Governance Process

The role of financial advisers in the corporate governance of listed companies ought to be a pivotal one. I am not so old but still remember a time when investment banks (or merchant banks, as they were known then) were often paragons of rectitude and the more reputable ones would not deal with a company if they felt it was acting improperly: not illegally, just improperly. Really, it is true. Of course, there were some that sailed close to the wind even then. I remember the time when I was involved in negotiating to buy Hard Rock Cafe and, at the very end of the deal - when everything was agreed - the advisers acting for the vendor raised the issue of their fees. Apparently they were not being paid by the vendor, having set up the deal speculatively, and wanted to land us with the extra cost. We were shocked. There was nothing illegal in this, just not quite cricket to leave it so late to tell us. Still, it was Drexel Burnham and Lambert and when you dealt with them you knew you were in the wild west.

Since then everyone has become inured to revelations about financial advisory firms. A recent Harvard Law blog examines the recent court case arising from Barclays behaviour in the del Monte takeover - where they advised and also misled the del Monte board. I would not have imagined that of Barclays in the past. And of course there is the opprobrium heaped on Goldman Sachs for selling investments to clients at the same time as other parts of their organisation described the securities in unflattering terms. Still, a City connection recently offered the opinion that people prefer not to deal with advisers they don't trust; and that over the next few years one may see the deal flow to some of these major institutions dwindling in quality and quantity as boards of directors go back to seeking advisers they can trust.

An interesting thought.

Thursday, 31 March 2011

Do the UK's regulators need regulating?

Who guards the guardians?

Ian King wrote this in the Sunday Times.

For an organisation seemingly hell-bent on transparency and disclosure, the Financial Services Authority was unusually tight-lipped yesterday following news that, after an investigation that began in April last year, it will take no disciplinary action against Guillaume Rambourg, the former Gartmore fund manager.
Yet a statement from the watchdog is surely merited. It is no exaggeration to say the FSA’s investigation has contributed to the near-destruction of Gartmore and cost its shareholders millions. When news broke that the FSA was investigating Mr Rambourg, on June 1 last year, shares of Gartmore fell by more than 5 per cent. By the time he quit six weeks later, to try to clear his name, they were close to their all-time low. Gartmore went on to suffer a big decline in assets under management and, in January, fell into the arms of its rival Henderson.
Eerily, news of Mr Rambourg’s exoneration comes as the FSA threatens to reduce another business to rubble....
 It seems to me that if good corporate governance is to be enforced by regulation and by regulators that those bodies need to behave responsibly and transparently. Of course they may make mistakes and they may be unable to find evidence to support suspicions. That is reasonable. But to take almost a year to investigate and then to give no public indication of what has happened is an outrageous abuse of process. Lives have been shattered, careers destroyed, savings annihalated. Was it necessary to announce the investigation in the first place? Might the wording of the announcement have been framed to limit the damage? Was it necessary to take nine months over the investigation? Could all these losses have been avoided?

If regulators can cause such damage without having to explain themselves to anyone do we risk adopting the worst aspects of Russian abuse of administrative systems?

UK Bribery Act - Ministry of Justice Publishes Guidance

Implementation of the Bribery Act 2010 was delayed from April 2011 as a result of concern that it was unclear and onerous but it will now commence on 1 July 2011. The updated Guidance note from the Ministry of Justice was released yesterday.
Justice Secretary, Kenneth Clarke, said:
'I have listened carefully to business representatives to ensure the Bribery Act is implemented fully and in a workable, commonsense way – this is particularly important for small firms that have limited resources. I hope this guidance shows that combating the risks of bribery is largely about common sense, not burdensome procedures. 
 Hmmm. The main change from the previous guidance is that there is a surrounding appeal to common sense. That is welcome and, as long as the courts follow that in practice, is good news. The guidance emphasises that onerous bureaucratic procedures to document activities to demonstrate compliance are not really necessary. Which may prove to be bad news for the consultants, accountants and lawyers intent on making their fortunes from giving unnecessary advice on the legislation to companies and persuading them to introduce unnecessary systems.

The MoJ repeats that proportionate corporate entertainment will not be illegal. It opens up the idea that companies that list in the UK but have no activities here will not be caught. It suggests that foreign subsidiaries may be deemed to make their own decisions.

However, the key point remains that interpretation of the Act will depend upon the courts. Will they apply common sense? We will see what happens in practice.

Tuesday, 22 March 2011

Financial Reporting Council guidance on board effectiveness

In early March the FRC published a guidance note on board effectiveness, designed to help companies implement the Code of Corporate Governance. It might have been an important document but  in the event I fought equally against unworthy giggles and yelps of outrage and time and again I failed.  It all starts badly with "The board's role is to provide entrepreneurial leadership... etc". Now FTSE 350 companies, at whom this is aimed, have many qualities but their sheer size and organisational complexity means that very, very few of their directors are entrepreneurs. Moreover there is a fundamental misunderstanding if the FRC believes that entrepreneurial behaviour emanates from a committee.

But stick with it, although the document reads like a list of thoughts for the day there are some useful thoughts, albeit they would have benefited from some focus. But then I came upon..."The CFO has particular responsibility to deliver high quality information to the board on the financial position of the company". Well, that's a revelation! Who would have thought that's what a Finance Director is meant to do? Such banalities really do not help the reader and nor do they encourage the reader to continue.

Still, I read on, although I was continually irritated by a peppering of references to "high-quality information" and "high-quality decisions", as if anyone tries to produce anything different. If nonsense was expunged the document would be half as long and definitely worth a read together with the newspaper in the morning. There is useful stuff here.

Early, for example, on the scene is set with a comment that  "An effective board should not becessarily be a comfortable place. Challenge, as well as teamwork, is an essential feature." Yes, absolutely right. This could have done with some expansion and there is some later on but these are important points to make you think. The balance between challenging your colleagues and working as an effective team is a tough one. More guidance on how you achieve that balance might have been useful.

I'd be interested in any reader responses to my disappointment with this guidance note.

Monday, 14 March 2011

Obama, Crowley, Manning and Corporate Governance

What do the conditions of incarceration of Private Bradley Manning have to do with corporate governance?

Manning is accused of being the source of material published by Wikileaks that may have compromised US security and has probably cost lives amongst informants whose identities have been compromised. On the one hand the allegations against him are serious whilst on the other hand he is being held in conditions that amount to torture. He has been held for nine months under conditions that include "nudity, prolonged isolation, harrassment and sleep deprivation." Prison psychiatrists have denounced the justification put forward for such conditions.

Challenged about this unconstitutional abuse of a remand prisoner, State Deparytment spokesman P J Crowley dubbed it “ridiculous and counterproductive and stupid.” and, as a result, was rapidly forced to resign.

So the link to governance is that we have improper behaviour by subordinates, associated with steps to cover it up and then a classic whistleblower who is promptly victimised. So the issue goes to the very top, to president Obama...

Obama: "With respect to Private Manning, I have actually asked the Pentagon whether or not the procedures that have been taken in terms of his confinement are appropriate and are meeting our basic standards. They assure me that they are. I can’t go into details about some of their concerns, but some of this has to do with Private Manning’s safety as well."

At the top you need ethical responsibility. Instead Obama asks the perpetrators of the questionable behaviour to self-certify that they are behaving properly. He also seeks to cut off debate by saying that there are things that cannot be discussed. All this is played out in the public realm where the checks and balances of governance ought to hold his government to account. Unfortunately the American body politic tends to be quite casual about morality in regard to their enemies; vide Guantanamo, water boarding, prisoners in general and now Manning in particular.

As with most corporate governance issues there are consequences to this behaviour. The moral standing of the US is further eroded and now both Republican and Democratic administrations are tainted as hypocrites. This will undoubtedly affect US interests when it seeks to speak for the 'free world'. The power of a nation lies in more than its military and financial power but also in its influence and moral standing. The parallel with corporations is that they too suffer real damage when their reputation is damaged through poor governance.

This is not meant to be a political post nor even about human rights: it is about the checks and balances in a system that prevent wrongdoing, abuse of power and behaviour that will damage the long term interests of a corporation. The example, from the world of government, illustrates the need for ethical standards and moral courage at the top and for stakeholders (in this case citizens and voters) to stand up and be counted when their servants go wrong. These behavioural issues are as vital to good governance as good systems and procedures.

NGO's and governance

There was recently an event sponsored by the UK government at which aspiring non-executive directors could meet organisations such as museums, galleries, artistic and cultural organisations that receive public money. It was an eye opener and a shocker. This was because of what they were looking for and what they were not looking for. Representatives of the organisations were very keen on recruiting, for example, scientific skills for the Natural History Museum or extolling the value they had obtained from a lawyer who had joined another public body. It quickly became clear that most of these organisations seek non-executive directors who will provide free professional services. What they are not looking for is people who will involve themselves in governance issues, who will challenge executives either by providing new ideas or testing those that are presented. They are not looking for people to contribute to new strategic thinking nor are they looking for the diversity in background and approach that leads to new ideas and challenges to the status quo.

In short they were not looking for the skills and approaches that should actually be the prime purposes of non-executive directors. Professional expertise you can buy in and is not so expensive in the context of these large organisations: a questioning, independent mind is, of course, less comfortable.

All these organisations may be lucky. They may hire excellent, innovative executives who will achieve great things and do not need holding to account and who do not need prodding to test new approaches. Or they may not; and the public purse will be wasted, organisations may become complacent and stuffy and may under-perform. Wilful misappropriation of public funds may occur and may go undicovered. My guess is that the latter is more likely than the former. What do you think?