Scandals, shocking in scope and cynicism, have marred the corporate landscape for too long.
This is the first installment of a 3-part series exploring structural solutions to certain deficiencies in corporate cultures that can lead to major wrongdoing
According to a study cited in a BBC report, “poor standards have cost the UK [bank] industry £38.5bn in fines and customer redress over 15 years”, and “[i]n the six years between 2008 and 2014, [UK] banks received 21 million complaints.”
The legal tab for the largest banks in the US since the financial crisis has reportedly exceeded $107 billion.
Scandals abound in other industries as well, be it emissions cheating software built into millions of VW diesel engine cars, or pharmaceutical fraud in the US.
As Liam Dowd argues, “it mostly boils down to culture - or the lack thereof”.
I too have advocated truly open cultures, in which front line employees are encouraged to voice ethical concerns up the chain, as a key approach to managing conduct risk and engaging employees in their company’s mission.
Openness works hand in hand with compliance-driven guidance on culture, such as rules on customer dealings.
As William C. Dudley, president of the Federal Reserve Bank of New York, noted while recently addressing a forum on improving bank cultures:
“In addition to a strong compliance function, firms need to foster an environment that rewards the free exchange of ideas and views. Individuals should feel that they can raise a concern, and have confidence that the issues will be escalated and fully considered. This is a critical element to prevention. A firm's employees are its best monitors, but this only works well if they […] expect to be heard and their efforts supported by senior management.”
Senior management sets the tone for company culture, and tomes have been written to advise them on how to guide it.
Given all the valuable advice on right culture, why do many companies still fail to get the culture right?
Disincentives at the top?
Perhaps more focus is needed on potential disincentives for senior officers to genuinely open up the culture.
Generally speaking, under US law - and UK law appears basically similar in this respect – with few exceptions, it takes a finding that a senior officer either had prior actual knowledge of, or intended to cause to be committed, a corporate wrongdoing engaged in by other employee(s) before he can be held liable for such misconduct.
Therefore, there might actually be a legally-based disincentive for many senior executives to probe, or encourage up channeling from, the lower ranks as to problematic behavior. If such executives knew of the conduct, and it turns into a scandal, they could lose the legal defense of lack of knowledge or intent.
Moreover, the oft-encountered overlapping business areas and functions and crisscrossing lines of reporting in large companies could lead to diffusion of a senior officer’s sense of personal responsibility for problems down below.
As noted by the US Department of Justice in connection with its new focus on prosecuting individuals for corporate wrongdoing:
“In large corporations, where responsibility can be diffuse and decisions are made at various levels, it can be difficult to determine if someone possessed the knowledge and criminal intent necessary to establish their guilt … This is particularly true when determining the culpability of high-level executives, who may be insulated from the … misconduct …”
Such disincentives dovetail with what UK’s Parliamentary Commission on Banking Standards (PCBS) famously referred to as the “accountability firewall” in its 2013 review of causes of UK’s bank scandals:
“One of the most dismal features of the banking industry … was the striking limitation on the sense of personal responsibility and accountability of the leaders …for the widespread failings and abuses … Those who should have been exercising supervisory or leadership roles benefited from an accountability firewall between themselves and individual misconduct … Senior executives were aware that they would not be punished for what they could not see and promptly donned the blindfolds.”
As part of this observation, the PCBS also warned against structural diffusion of responsibility:
“Where [senior officers] could not claim ignorance, they fell back on the claim that everyone was party to a decision, so that no individual could be held squarely to blame…”
A perverse consequence of such obstacles to individual accountability at the top has been that senior executives can set lofty business goals for underlings that almost ensure cutting corners.
These executives can reap the rewards if the goals are met, and largely escape liability if underlings had to engage in untoward behavior to meet those goals.
In the US, as NY Times observes:
“The entire structure of a corporation is intended to protect and insulate high-ranking executives, who are often shielded from knowledge of wrongdoing, even if they have tacitly approved it.”
The article further quotes the finding of Professor B.L. Garrett that “[m]ore often than not, when the largest corporations are prosecuted federally, individuals aren’t charged”.
To add insult to injury, losses from misconduct have on occasion been so massive that taxpayer-funded bail-outs were required, as exemplified by much of the bank losses in the lead-up to the financial crisis on both sides of the pond.
Yet, as The New York Times reports,
“…[with rare exceptions] not a single individual at a Wall Street company, or other financial institution, who engaged in fraudulent behavior in the years leading up the financial crisis has been prosecuted successfully.”
Similarly, the PCBS noted in its review that, in the UK,
“[t]he public are rightly appalled by the small number of cases in which highly-paid senior bankers have been disciplined for the costly mistakes they have allowed to occur on their watch.”
Turning the tables
In recent years, both government and private initiatives have been undertaken in the US as well as the UK to render senior officers more accountable for misconduct by their firms.
These efforts may serve to remove or at least chip away at the accountability firewall.
Without the protection of the firewall, senior officers should be more motivated to probe the lower ranks for problematic business practices, and encourage up channeling and effective questioning by employees at the front lines.
As the PCBS advocated:
“It is imperative that in future senior executives … have an incentive to know what is happening on their watch—not an incentive to remain ignorant in case the regulator comes calling.”
Such openness should help to uncover or forestall potential misconduct that might ensnare the senior executives.
Moreover, should any misconduct actually occur, openness should facilitate the firm’s speedy reporting of the misconduct to regulators, which can be a basis for more lenient regulatory or prosecutorial treatment.
The next installment will examine certain US regulatory regimes and a market-based proposal aimed at individual accountability at senior management levels for corporate misconduct.
Wilfred Chow is a US-based researcher and writer on corporate responsibility, governance and ethics and sustainability. He previously served as a managing director and associate general counsel at a leading financial services firm in the US.culture Wilfred Chow accountability scandal compliance