Governance Gateway Blog

Bribery, Cyber-Security and Derivatives: Is Internal Audit up to the Task?

May 25

Posted in Audit Committee, Risk Governance and Combined Assurance | No Comments »

Do internal auditors have the resources, skills and authority necessary to do their job? I wonder. I was asked recently to be an expert witness in an alleged bribery case. Internal audit is one of the first places I look to when assessing governance failure because they are the eyes and ears of the board.

I asked a question recently at two auditing conferences I spoke at. How many auditors use Twitter? In both cases, only one hand went up. Yet we know cybercrime is widespread, is under-reported, and management may not even know it is happening. It is a top concern of boards. How can internal auditors assure internal controls – not only over cyber-security but social media – when they themselves may be technically illiterate? IT literacy and data mining were two of the top skills required by internal auditors in a recent survey.

What about derivatives used by traders? How many auditors understand the use of derivative products such that they can attest to the internal controls over their use? The responses I received from my audiences were not encouraging.

What about corruption risk? How do auditors treat working notes, delegation to foreign auditors, language barriers, and do they even understand foreign practices? Do they visit the jurisdiction or audit from an office in Canada? The OSC came out with a scathing report recently about emerging market risks, chastising not just boards but the audit and underwriting professions.

What about fraud? Evidence from the conference board is that many whistle-blowing programs don’t work and aren’t used. Now whistle-blowers can go directly to the SEC in Washington, completely by-passing possible retaliation, flawed investigations or toxic workplaces.

Auditors cannot choose which internal controls they validate. Regulatory authorities are clear: every activity of every entity should fall within the scope of the internal audit function. This includes compensation structure of risk-takers. Combined assurance over all material risks should be undertaken.

Management may have vested interest in starving internal audit or compromising their objectivity with management responsibilities. Regulators have been clear here also: auditors, both internal and external, must maintain their independence from audited activities. They cannot assess their own work.

If the internal audit function is weak, or the chief audit executive does not have the experience or stature, or management disregards internal audit findings, this is the fault of the audit committee and the board. The audit committee should approve the head of internal audit, his/her compensation structure, the budget, work-plan and most of all the independence of the internal audit function. If the audit committee and ultimately the board does not ensure this, it is not doing its job. When or if governance failure happens, scrutiny will follow.

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Derivatives May be Ungovernable

May 18

Posted in Audit Committee, Financial Reporting, Risk Governance and Combined Assurance | No Comments »

The recent loss of 2Billion dollars by JPMorgan confirms what is now a blindingly obvious governance reality. Board of directors do not understand derivatives and cannot control management’s use of them. The same may be said for regulators.

One job of a board is to identify risks and ensure a proper system of risk management. If you cannot do this, you should not be on a board. This means that a director needs to assess the adequacy of the design and effectiveness of internal controls to mitigate the risks. Of the over 300 interviews I have undertaken in my research, including directors of large banks, only one director claimed to understand complex derivatives. How can directors assess internal controls when they do not understand the very instrument itself?

Other than Jamie Dimon, CEO of JPMorgan, not a single director of the board has any experience in banking. See the roster of directors here. Even if some directors were from the sector, it is debatable whether they would still understand the complexities of these products. For a basic explanation of what derivatives are, see here. U of T Rotman professor John Hull, a derivatives expert, has stated in an email to me “There is no question in my mind that a large financial institution should have on its board people (perhaps 2 or 3) who understand derivatives and other complex financial products.” Unless bank boards that oversee derivatives are prepared to have subject matter experts on their board who can effectively question management and insist on proper risk controls, other governance or oversight structures are needed.

Not only are boards incapable of controlling derivatives, but regulators may not be any better. Warren Buffett has said “Central banks and governments have so far found no effective way to control, or even monitor, the risks posed by these contracts. In my view, derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.” See Warren Buffett on Derivatives.

The question is what have we learned from 2008? Banks are bigger than ever, with most American mortgages concentrated in only a handful of banks, yet the risky bets and use of complex derivatives continue. Harvard law professor Elizabeth Warren yesterday called for a new version of the Glass Steagall Act. Yet independent Senator Bernie Saunders pronounced that Wall Street “runs” the Senate, implying that any attempt at further regulation would be forestalled. Mitt Romney has vowed to unwind Dodd-Frank on his first day as President. Look at the long list of political donations made by JPMorgan in 2011, here. And this is just one bank.

If derivatives are going to continue, regulatory conflicts of interest need to be addressed and boards need to have the directors with the expertise to oversee them.

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The Battle for CP ~ Welcome to the Great (and Cozy) White North, Mr. Ackman

May 17

Posted in CEO, Organizational Performance and Compensation, Global Corporate Governance, Member Selection, Competencies and Commitment | No Comments »

By now, you may have heard that Canadian Pacific CEO Fred Green, Chairman John Cleghorn, and four other CP directors have resigned or will not stand for re-election, to make way for Pershing Square’s Bill Ackman and a new slate of CP directors – and a new approach to corporate governance in Canada.

The Pershing Square bid is the perfect storm for what is wrong with Canadian corporate governance: (i) the lack of attention to strategy; (ii) the lack of shareholder accountability; and (iii) the lack of directors with domain expertise. It represents a tipping point for any board in the way it does – or should do – business in Canada.

Lack of Attention to Strategy

The “Dey” Guidelines are now almost 20 years old. They are outdated. Much has changed in corporate governance. Canada needs revised and updated guidelines to the 2005 National Policy, which incorporated many of the Dey guidelines. The Dey guidelines from 1994 contain six words on strategy: “adoption of a strategic planning process,” which is inherently ambiguous. The 2005 National Policy is not much better, adding that the board must approve a strategic plan at least annually. (Emphasis added).

This approach to strategy is wholly inadequate, and the consequences are obvious. In an Institute of Corporate Directors session I facilitated of ninety-four directors last week, when a question on the board’s role in strategy was asked, two panelists deadpanned “we do it in a superficial way” and “it doesn’t happen.” Boards have become obsessed with compliance at the expense of value creation for the company and shareholders.

The research – from Ernst and Young, Egon Zehnder and McKinsey for example – confirm that a more engaged board under a private equity governance model will outperform their public company peers, by a factor of three to one. This outperformance under a Bill Ackman model cannot be ignored by public companies. For academics who desire to show a more causal link between governance and performance, as do I, it should not be ignored either.

The deep dives and due diligence conducted by Pershing Square – over 100 pages in total – should be conducted by boards if they are doing their job, and wish to keep hedge funds from knocking at their door. But there is code like “nose in fingers out” or “micro management” used by Canadian CEOs and directors themselves that keeps directors from performing their strategic role.

The evidence of CP is a case example: Seven COOs and CFOs were replaced in the last five years; CP has consistently underperformed across its peers, including its Operating Ratio; and yet CEO Fred Green met 17 of 18 objectives set by the CP board. And the board moved those targets, resulting in the cost of management as a percentage doubling.

Public company boards need to be much more engaged in strategy, and demanding of management. As reported in the Journal of Applied Corporate Finance, value may be “left on the table” ~ which would invite sophisticated investors like Bill Ackman to come in.

I have reviewed public and private plans by activist shareholders and private equity firms and there is no comparison to the often “superficial” (to use a word from above) approach to strategy typically taken by public company boards. There is absolute clarity under private equity what management is held responsible for, and variances to be reported in advance to – and understood by – the board. Boards of this caliber are much more engaged and focused on shareholder value. No stone is left unturned.

Lack of Attention to Shareholders

Second, many public boards in Canada do not meet directly with shareholders, or if they do, it is behind closed doors – the “cozy” Canadian way. Bill Ackman did not accept this and was unwilling to compromise or go away. This cozy environment has to change, including shareholders asserting themselves much more. And lawyers cannot unduly influence this communication.

Most importantly, Canadian shareholders should have proxy access, or the right to nominate directors of their choosing and put those directors on to the proxy circular, which is another American development that makes sense. It should not take Pershing Square, a 14% shareholder of CP, CP’s largest, a long, protracted, expensive proxy battle to implement governance change. Vote counting, majority voting, plurality voting, etc., are window dressing. Shareholders should have the right to nominate directors to boards and fire directors who do not perform, with ease and transparency. The threshold should be low, or even based on the company’s largest shareholders.

In addition, Canadian directors need to have a % of their net wealth at stake in the boards on which they sit, for true shareholder accountability and alignment. This does not mean directors receiving shares for board service, but actually issuing a check from their savings. The CP board owned 0.2% of stock and it was given to them, not bought. If one director, had $100M of his or her own wealth invested, the CEO would be replaced, Pershing Square said.

Lack of Attention to Domain Expertise

Lastly, the entire board of CP, other than the CEO, did not have rail experience prior to Pershing Square’s involvement. This is a direct consequence of the Dey guidelines from 1994, even though the research does not support independent directors and firm performance. The reason is that if directors do not understand the business, or industry, they are under-engaged in strategy and even their ability to monitor is compromised. They don’t understand. Look at the board of JPMorgan, which lost $2B last week. Other than the CEO, not even a single director has banking experience. If a director does not have experience in the sector, they cannot identify the risks.

Pershing Square’s directors have been selected on the basis of railroad expertise, restructuring expertise, shareholder representation, entrepreneurial culture and a culture of equity ownership and shareholder value creation. What a breath of fresh air. Boards would be wise to take a page from the Bill Ackman playbook, or shareholders should themselves.

And, most of the above Pershing Square directors are from Canada. The notion that we have a talent shortage is a myth. If the board’s desire is for a “CEO,” then there may be a shortage, but the evidence from Stanford University is that CEOs do not make better directors. There is plenty of talent in Canada, and boards need to reach into the C-suite and into shareholder communities. And they need to diversify to mitigate groupthink. The directors exist. My own database contains hundreds.

The Need For New Guidelines

Shareholder accountability, strategic engagement, and director experience and skills, all point to shortcomings that are non-existent or short-changed in the Canadian corporate governance landscape. This is exactly what Bill Ackman brings to the table. Welcome to Canada, Mr. Ackman.

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Harvard and MIT Innovate: Rest of HigherEd Should Take Note

May 4

Posted in Teaching & Education | No Comments »

Something happened this week in higher education that you may have missed. Harvard University and Massachusetts Institute of Technology (MIT) teamed up to announce a $60M investment in “massive online courses,” known as edX. This initiative was said by the Atlantic to be “The single biggest change in education since the printing press.” In this nonprofit venture’s pilot course on “Circuits & Electronics” developed to test the market, there were 120,000 students. 120,000! Signing up for electronics! There were more students registering for this single online course than MIT’s entire entire alumni base, it was said in a press conference attended by both university presidents and the press. See the impressive video here.

Technology has come a long way in the last five years. Platforms are not clunky, but enjoyable, robust and user-friendly. Just as boardrooms are becoming paperless, through the use of portals and tablets, so should classrooms. However, more change is coming in the delivery of learning and access to global students in emerging markets. For universities, this means competition is now global, beyond the bricks and mortar of their campuses. Of course, companies compete globally already, but boardrooms too will change. Global directors will be able to participate in board meetings without leaving their home country, and without a decline in meeting quality. Shareholders will have access to boards and companies directly through their computers or even smart phones. Technology makes interactive, instantaneous communication and voting possible in ways we may not even imagine.

Do the numbers bear out a $60M investment in online learning and digital media by Harvard and MIT? Consider this as a real sample: I am scheduled to teach Corporate Governance this summer at Harvard University. The course currently has 33 students enrolled. A governance course I taught last year at Osgoode Hall Law School also had 33 students. A course I taught to undergraduate law students had only 6. However, my LinkedIn group, Boards and Advisors, now has 2,689 members and is climbing at a rate of 7-10 new members every day. We are not constrained by class size. We have group members from the Securities and Exchange Commission, the Office of the Superintendent of Financial Institutions, and Industry Canada (in the past week). I post everything I read and interact with members on a daily basis, facilitating discussions, stimulating peer dialogue and insight, and ensuring the proper tone. This group has more members than even those of the National Association of Corporate Directors in Washington and the Institute of Corporate Directors in Toronto (at 2,043 and 1,293 members respectively). Directors thirst for content, dialogue and networking, all of which occur in this group.

Consider this too: Of the total universe of corporate directors, most do not attend in-person conferences at director associations or universities. It is too costly and not a wise use of their time. At the NACD annual conference, about 800 directors attend. But there are 10s if not 100s of thousands of directors on public, private and nonprofit boards, within the US alone. Would these directors want to have access to learning that was convenient, interactive and customized to them, at a reasonable price? Hmm, I wonder.

Harvard and MIT are banking on the fact that students in India, China (with 100s of millions of people and ~ 8% growth rates) and all over the world will use home and office computers to take their courses, without having to come to Boston as residential students. They are investing in a nonprofit venture to ensure robust platforms, customized learning to suit each student, processing of big data and tests in real time (which will assist research), and internal controls over academic integrity – all with a view to come as close as possible to the classroom experience in real time, and in some respects superior. Even instantaneous language translation may be possible. Mouse or cursor analytics tracking may tell teachers and researchers how students learn and what works and doesn’t. Courses will be free and universally accessible, but eventually users may likely pay. Certificates and degree programs are also possible.

Speaking of brand and the ability of universities to deliver online education, it is also debatable whether private companies or associations are best to deliver education. They may be conflicted with service providers who pay-to-participate in programs, which affects the curriculum. Private for-profit companies may not devote resources keep platforms or curricula current, or ensure internal controls over marking and integrity. The best programs may ultimately be academic-practitioner team-teaching where the academic brings rigor and proximity to research, and practitioners bring real world experience.

This movement by Harvard and MIT is a game changer that signals potential obsolescence of traditional educational delivery that refuses to change. But it also points to governance shortcomings of universities who are behind the curve and bloated. Technology should bring costs down to the end user, not up. However, costs to students even with technology to date continue to rise, as does class size. Students graduate with crippling debt. Witness the student demonstrations in Quebec, which have received worldwide attention. Boards of universities are too large and should be populated with more hard-hitting businesspeople with a stellar track record and mindset of innovation and value creation, who not only see the future but have helped shape it, and who can tell university presidents which way to part their hair.

Governance reform in healthcare has started, but needs to extend to education. In hospitals, for example, there was a survey that revealed that most hospital boards do not pay the CEO for performance. (This is the most important responsibility a board has.) Shortly thereafter, the Premiere of Ontario in 2010 enacted legislation (see “An Act respecting the care provided by health care organizations”) to compel boards and senior management to measure quality for stakeholders, and link these quality metrics to executive pay. (See summary slides here.) These reforms are now under way and the Ontario Hospital Association is commended for its efforts in pay for performance (see March 2012 slides here and a backgrounder here), and focus on governance (see the OHA’s Governance Centre of Excellence here). This is exactly the type of reform that is sorely needed in universities. There are layers of administration without any visible linking of pay to performance. Costs are being passed on to students, who can least afford it. Quality metrics should center on innovation and the classroom for universities, similar to wait times for hospitals. Value and cost savings are being left on the table for universities.

Just yesterday I walked by another bookstore in my neighborhood that has closed. Change is afoot and the longer higher education waits to innovate, the more compromised they – and society – will be.

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Canadian Pacific is a Teachable Governance Moment

Apr 20

Posted in Board and Committee Leadership, Independence and Role Clarity | 2 Comments »

The fight for Canadian Pacific Railway (CP) by activist investor Pershing Square demonstrates several shortcomings in the public company governance model and what can be learned from private equity. CP and RIM are significantly underperforming Canadian companies. There are numerous others. The question is where is the board?

The current corporate governance model is largely focused on compliance, not on value-creation. Most regulations short shrift the board’s strategic and value creation role. Canadian guidelines address strategic planning in one sentence, at 3.4 (b). The NYSE rules do not contain the word “strategy.” Educational programs are overwhelmed by auditors, lawyers and pay consultants. Boards have become bureaucratic traffic cops and the trend is continuing after 2008. How would codes and educational programs look if they were drafted and taught by long-term active investors?

Regulators in large measure are to blame. They overemphasize structural board independence at the expense of industry knowledge and shareholder mindset. The separation of chair and CEO and having a plethora of independent directors accomplishes little unless there is a clear understanding of roles. Most chair and director position descriptions are little more than high-level one or two page compliance documents written by lawyers designed to keep directors at bay. Directors are selected for independence and profile because that’s what the regulators want. Yet scholars know research does not support independent directors and the creation of shareholder value. What is missing? What can we learn from activist investors and private equity?

Here are some facts about CP according to Pershing Square’s materials and presentation:

All directors own < 1% of stock and it was given to them, not bought;
Four COOs and three CFOs have been replaced in the last five years;
CP has consistently underperformed across industry peers, yet the CEO met 17 of 18 objectives set by the board;
The cost of management as a percentage has doubled;
There has been a moving of targets by the board, and these targets have been meaningfully lower than CN’s;
There has been a lack of rail experience on the board, shareholder representation or equity ownership; [CP did not have any railroad expertise to drive the value creation process on the board (other than the CEO) until Bill Ackman first launched his activist efforts]
If one director had $100M of his or her own wealth invested, the CEO would be replaced, Pershing Square said;

Deep dives such as the above by sophisticated activists such as Den Loeb and Bill Ackman need to be undertaken by boards themselves. This dive need not be overly complex. Look at Ironfire Capital’s analysis of the New York Times. How many boards have the skills to do this, I wonder? The approach Bill Ackman brings is not exclusive in its applicability to under-performers. The fundamental question is how many companies are under-performing relative to their potential, just not to the extreme extent of CP? And does this speak to a more robust corporate governance model on a wider scale?

We can learn from private equity and the nature of board engagement and shareholder value creation. According to experienced chair and activist investor, Henry Wolfe, “Numerous studies have been done of the performance and value creation results of private equity portfolio companies compared to their public company peers. At least in all that I have seen, the studies clearly demonstrate that private equity companies significantly outperform.” Wolfe goes on to say, “The implications of these comparative results for public companies is or at least should be staggering to those who serve on or advise public company boards. Adding fuel to this point Ernst & Young and other studies, including by McKinsey, found that the primary driving force for this out-performance was the PE Corporate Governance Model.” See the following link to an Egon Zehnder Private Capital Thought Leadership article regarding the work they did to learn more about a McKinsey study on Private Equity.

Michael Jensen at Harvard from his panel role in the 2007 Morgan Stanley Roundtable on Private Equity and its Import for Public Companies, said “In fact, my sense is that the due diligence process that the buyout firms go through in vetting and pricing a deal causes those principals and their managers to learn more about the business than has ever been known since it was a public company.”

This should not be the case if the public governance model worked. A key disconnect is director-shareholder accountability, which is not the case in private equity.

The nexus between public company boards and shareholders who own the company is limited at best, and this affects motivation and accountability. Boards continue to entrench themselves through staggered elections, at the expense of shareholder value. Most boards do not actually engage with shareholders directly other than at a perfunctory annual meeting. Shareholders cannot even propose directors in the proxy circular. A recent proposal by a group of Canadian investors is recommending (see the “Roxborough Initiative”) not only that shareholders select but also that shareholders – not management – compensate directors. This would address incentives and accountability. Director performance reviews should also be shared with shareholders and shareholders should have a say on board chairs. We are a long way from this type of meaningful board-shareholder accountability.

It is time to push the envelope and rethink the current model of corporate governance, in terms of how directors are selected, directors’ fundamental understanding of the business and the value creation process, the role of the non-executive chair, and director accountability to shareholders.

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Augusta Golf Club Needs to Get Real and Admit Women Members

Apr 13

Posted in Diversity, Women on Boards | No Comments »

CNN’s Piers Morgan, Masters winner, Bubba Watson, Donald Trump and National Association of Corporate Directors’ (NACD) CEO, Ken Daly, all weighed in this week on Augusta National Golf Club’s policy of excluding women members. See, if you are interested, the list of Augusta’s all-male membership roster, curated by USA TODAY, here.

Ken Daly, in an NACD webinar on ethics and capitalism, called Augusta’s policy of excluding women “DS,” which, he said, stands for “damn silly, in 2012, when women comprise 51% of the population.” Augusta’s policy was a trending issue in social media, including LinkedIn and the twitterverse, with governance leaders Sandra Rupp, Jayne Juvan, Frank Feather and Ray Williams weighing in. Even a petition has started to admit IBM’s first female CEO, Virginia Rometty, who watched on the sidelines with a pink jacket instead of a member’s green one. IBM is a major Masters sponsor and Augusta “has a history of inviting the company’s top executive to join its club.”

Why is the exclusion of women members by a private golf club a corporate governance issue?

It is an issue because all over the world now, in dozens of countries, there is a movement to the diversification of corporate boards and senior management teams in order to make better decisions. Director and executive recruitment and networking is done on golf courses. Excluding women has business consequences for them. This is also about corporate leadership and values of IBM and Augusta National.

Private clubs or associations are not islands. They pay taxes, often enjoying nonprofit tax advantages on behalf of taxpayers, and have corporate sponsors, advertisers, governing bodies (such as the PGA), customers, suppliers and local communities. Still, less than 1% of America’s golf clubs exclude women. This is a signaling issue in that it is okay to discriminate. By extension, stakeholders interacting with clubs that discriminate endorse and enable the practice.

This is also a membership issue for clubs themselves. I was asked by a new female board member last month to lunch to advise her on bringing governance reforms to a very prestigious club. As I sat in the dining room, it was almost empty. I remarked that female, minority and younger members were the future of the club, given changing demographics. And the club needed to “get real” about diversity, as well as its governance, and have transparent, inclusive policies. There is little if any substantive disclosure of how Augusta is governed on its website and how decisions are made. This is always a red flag for me and tells me an organization may not be person-proofed or have up-to-date policies.

Just in the last month, Julie Dickson, head of the Office of Superintendent of Financial Institutions (OSFI), the Canadian regulator for financial institutions, addressed in a speech the importance of boardroom diversity to avoid groupthink. (OSFI’s 2003 guidelines are expected to be updated by the summer.) The Conservative government announced in its budget an advisory council to promote women on boards, under the leadership of Minister Rona Ambrose. EU Justice Minister, Vivian Reding, also a woman, has indicated that she is prepared to use quotas if companies do not raise the number of women in senior management and on boards.

Golf is part of business. As Melisa Denis, Women’s Advisory Board member at KPMG, stated in the LinkedIn Group, Boards and Advisors, “I just came back from Augusta this weekend. If anyone doesn’t think this is business they are naïve. Business is done on the golf course – whether you are playing or not. To deny membership because the CEO is a female puts this country back 20 years (at least).”

Augusta National needs to “get real” about women members. Interestingly, the NACD is also offering events to discuss how corporate boards can “get real” about diversity too. Well done, NACD.

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SNC Lavalin and RBC in the News

Apr 4

Posted in Ethical Leadership, Citizenship and Integrity, Risk Governance and Combined Assurance | No Comments »

If the CEO of SNC Lavalin allegedly over-rode his own CFO and breached the company’s code of ethics in authorizing $56 million of questionable payments to undisclosed agents that the federal Canadian police are now investigating, did the board of directors of SNC Lavlin have a role to play?

If the RBC (formerly Royal Bank of Canada) is alleged by a US regulator to have made “material false statements” in connection with non-arms length trades, reported in the Wall Street Journal to be “a scheme of massive proportion,” did the board of directors of RBC have a role to play?

The answer is “it depends” in these and similar cases. Speaking generally, as all allegations have yet to be proven, it is not credible to argue that boards do not have a role to play in compliance and reputational oversight. A board is the only body that has the legal authority and power to control management and designate all compliance and control systems. It alone acts or fails to act. A board is paid, handsomely paid at the senior most levels in Canada, to take all reasonable steps consistent with best practices, to ensure that it does know.

More regulation now, such as the UK Bribery Act, and the SEC Whistle-Blower Rule, are attempting to hold directors responsible and accountable for failing to direct proper anti-corruption and whistleblowing systems. The SEC rule enables employees to report wrongdoing directly to the regulator, thereby completely bypassing toxic work cultures where whistleblowing is neither independent nor anonymous. This legislation is putting the heat on boards and senior management, or at least it should be.

The Ontario Securities Commission last month released a scathing report about governance, risk management, internal control and auditing failures in companies operating in emerging markets.

In SNC Lavalin’s case, how could anomalous payments of this magnitude and internal controls be allegedly manually over-ridden, as is being reported, and would payments of this nature require explicit board or committee approval? SNC’s own internal report reveals a lack of disclosure of contracting parties and improper documentation and passwords. The board chair, Gwyn Morgan, said that the board wasn’t “able to really determine the use of those payments.” Back in 2010, federal minister Stockwell Day had signaled that certain aspects of SNC’s pricing were “absolutely unacceptable.”

The former CEO, Pierre Duhaime, is receiving almost $5 million dollars. A portion of this is stock options awarded before an independent review was completed, as is reported in the press. Basel includes (at page 38 of this report) a malus scheme whereby vesting occurs only if there is no breach of the code of conduct. Boards may wish to consider comprehensive – and independently drafted – malus or clawback clauses that include similar provisions.

It may be highly unlikely for fraud, bribery or ethical breaches to occur in a vacuum. Employees may have knowledge. The 2011 National Business Ethics Survey reveals that those who reported bad behavior they saw reached a record high of 65% and retaliation against employee whistleblowers rose sharply to more than one in five employees. The Conference Board’s Directors Notes, in “Lessons for Boards from Corporate Governance Failures” (see the PDF at page 3), reveals defects in whistleblowing systems that include lack of anonymity, lack of independence, lack of communication and training, lack of incentive, and lack of a proper investigation. These defects are exactly what the SEC rule is designed to address. As Chairwoman Schapiro has argued, “I find that many of the business ethics problems severe enough to be investigated by us are the result less of individual greed than of individuals succumbing to pressure from their peers.”

Whistle-blowing defects may be faults of a board. If a board is getting its information only from management, this is a red flag. Management may not even possess accurate knowledge, as we see in cybercrime. Independent assurance over anti-fraud and whistle-blowing procedures must occur for any prudent board. And “independence” does not mean the company auditor or legal counsel who assess their own or their firm’s work, nor any firm who does, has done, or seeks to do work for company management. Any assurance provider in this area could likely recommend action adverse to incumbent management or service providers.

Directors and boards themselves also need to step up. This includes international directors, moving board meetings to emerging markets, understanding corrupt business practices, structured deep engagement by directors, receiving third party assurance and disconfirming information (including culture surveys), and using alerts and social media. See “What Better Directors Do,” by NACD Directorship.

Both SNC Lavalin and RBC received governance recognition and were among the top twenty-five companies in the Globe and Mail’s Board Games for 2011. SNC Lavalin was the 2007 award winner from the Canadian Coalition for Good Governance.

The question therefore, is, could occurrences such as these happen on other boards of directors? If you are a director on a board and cannot reasonably answer “no,” to this question, perhaps you should consider some of the above recommendations.

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IT Skills Needed Around the Board Table

Mar 23

Posted in IT Governance | 8 Comments »

In a speech I gave this week to a large room of directors in Montreal, I asked for a show of hands as to how many directors use iPads. About 80% of the hands went up. When I asked the question a year ago, the figure was only about 20%. If you are a director who does not own an iPad, request management purchase iPads for all your directors, or better yet buy your own. Request that your board have a board portal installed. Within a year, most boards will be paperless. Good boards are now paperless. If a laggard director blocks technology or refuses to up-skill, the director should be asked to step down. Technology has gotten a lot easier to use in the last year.

Information technology literacy at the board table is rapidly becoming a must-have for boards, ranking up there with international, risk management and executive experience as necessary boardroom conditions on director skills matrixes. Termed an information technology “revolution” by some directors, technology is rapidly changing how boardrooms and companies operate and compete. IT skills are necessary not only for prudent risk mitigation, but more importantly, for strategic opportunity, innovation and the way companies communicate with a new generation of investors, consumers and employees. Virtual meetings, electronic reporting and social networks are now becoming the new communications platforms. Mailed proxy statements, in-person meetings, and even email may be a relic of the past.

If your board of directors does not have a solid understanding of IT-drivers, such as cloud computing, big data, consumerization, mobile computing, cyber-crime, e-corruption and social media, which are increasingly pervasive / possible throughout all industries and B2B and B2C companies alike, it will not have the clout with senior management to operate. It will not recognize deficiencies, weak benches, red flags, product/service distribution channels, or even basic opportunities or relationships to exploit (such as fundraising for not for profits). Management –and the competition for executive and employee talent– will perceive the board as dated. Management and investors can now go online and find out whether a director is IT literate or not.

IT literacy can no longer be learned on the job or though educational primers for older directors, as the turnover and learning curves are too great. The world is changing and the notion that a 65 or 70-year-old former executive possesses IT competency is a myth. Generational shifts and emerging demographics need to be embraced by boards, including recruiting IT subject matter experts and mentoring first time directors. Women, younger directors and other directors with IT expertise must be at the board table to have the credibility and experience with management to drive change and ensure that boardroom discussion contains multiple informed perspectives.

How does your board fare on the above? Specifically,

Does your board have enough strategic IT experience to advise management credibly?
Do you have a full understanding of IT opportunities and threats facing your company and industry?
Does the board have a committee that oversees IT risks, internal controls and reporting?
Do the company and your investor relations department use social media and other emerging technologies (such as shareholder forums) for engagement with institutional and individual investors?
Do directors use social media to listen and learn?
Are you satisfied with the quality of IT management?

These are some of the questions that need to be asked at the board table. Boards likely won’t get past the second question or the wrong answer by management if they themselves are not IT literate.

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Shaping a Not-for-Profit Board of Directors

Mar 9

Posted in Not-for-profit Boards | No Comments »

Should not-for-profit governance be short-changed because of scarce resources and directors being unpaid? Are directors’ fiduciary duties less because it is a volunteer position? Are directors less at risk?

The answer is “no” to all of the above questions. Not for profit organizations are some of the most important in our economy, including hospitals, schools, universities, charities, religious organizations, community organizations and more. Many are large, complex organizations with multiple moving parts and interdependent stakeholders. They are tough to lead and govern but must be as effectively led and governed as for-profits are. They require CEOs, directors and staff who are at the top of their game and will make the commitment necessary.

Beneficiaries such as patients, students, children, congregations, artists, the disabled, military veterans and the vulnerable all depend on a well-governed organization to survive and thrive. Without proper governance, donors are less inclined to give, directors are less inclined to serve, and the mission of the organization less likely be achieved. Not-for-profits can also be the first board a director serves on, so it’s important to learn the right habits at the outset.

I gave a speech in Dallas this week to 160 not-for-profit directors on shaping effective boards, for the University of Texas at Dallas. My slides are here (PDF) and the not-for-profit booklet that I co-authored and was published by the Canadian Institute of Chartered Accountants is here (PPT).

Here are some suggestions coming out of my speech and subsequent roundtables for improving Not-for-Profit boards, and based on my work with leading NFP boards, CEOs and directors. They can all be done with limited budgets and resources, whether you are large or small.

Formalize board roles. When I asked for a show of hands, most of the room did not do this. Have charters for the board, the committees, the Chair, the Executive Director, and committee chairs if you have committees. Samples of these are in my guidebook if you need them, and are also publicly available on the Internet. Tailor them and draft them yourself. This gets everybody on the same page and establishes standards and the right tone at the top.
Your board mandate should address vision, mission, strategy and operational plans; program delivery and operations; risk identification and management; finances (budgets, investments, use of donations, etc.); government filings and reporting; values, ethics, reputation and integrity; key policies and procedures; and communication and accountability to members and stakeholders.
Consider gradual terms of two years and three renewals; or three years and two renewals, contingent on performance, whenever possible, to promote renewal and diversity and allow fit and interest determination. Confirm a succession planning process.
Mentor and recruit younger directors. Have them serve on a committee but not become board members until they gain a few years experience. Pay attention to needed skills that older directors may not possess such as social media and its impact on fundraising. Have a board talent pipeline.
Have tight board and conflict of interest guidelines that addresses directors who are also volunteers; directors who are also stakeholders; and donors who sit on boards who need governance training.
Recruit properly and limit the size of the board. Use a director skills matrix that is aligned with the strategy and mission of the organization. Limit the size of the board so it’s effective at decision-making.
Adopt an evaluation process – annual and perhaps per meeting.
Be explicit and up front about donation and solicitation expectations, but be flexible for different capacities. Notify the board about average gift amounts to encourage giving.
Always say “thank you,” seven times. (Yes, thank a donor or volunteer or other stakeholder who gives a total of seven times.)
Lastly, have fun and be passionate. NFP directors are some of the most passionate, generous and fun people in the governance space. They serve because they genuinely believe in the cause of the organization.

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Does Canada have a White Collar Crime Problem? A Red Flag Checklist for Directors

Mar 2

Posted in Audit Committee, Risk Governance and Combined Assurance | No Comments »

“This city, this province, this country has a reputation of being the best location to carry out white collar crime, corporate fraud, in the industrialized world.”

These public words are not from some scholarly journal but from a hard-hitting, no-nonsense corporate director, Spencer Lanthier, (PDF profile) as he received his award at the annual Institute of Corporate Directors dinner last year – a sort life-time achievement award for a select few directors. Guests at my table were shocked to hear this, as was I, so I followed up to interview Mr. Lanthier for an illuminating interview. I also went for lunch with former colleague Al Rosen who wrote the book “Swindlers,” which I am now reading and equally eye-opening.

Flash-forward to 2012 where the Nortel trial is now underway to examine what role directors or officers might have played in that alleged fraud. See a headline from last week: “Toronto lost nearly $1M to fraud in 2011, auditor-general reveals”and the twelve cases identified by the auditor general. See this excellent report (PDF), courtesy of Tim Leech in my LinkedIn group Audit Committee.

Here are some questions: Do directors on boards play a role in detecting and deterring fraud? Can they be held responsible or even liable if they do not fulfill this role properly? Increasingly the answers are “yes,” especially given UK and US legislation since the financial crisis. I remember one of my very first board meetings I observed. It was of a bank. At the break, a director got up and shook my hand. He leaned over and whispered in my ear that the number one role of a director was to watch for fraud. I never forgot this.

Here is a list of 10 red flags and suggestions I have compiled based on my work recommending governance enhancements for companies accused of fraud or other malfeasance, including very well known Canadian companies.

1. The Audit Committee must fully understand how the company’s business model, estimates and judgmental choices by management give rise to potential manipulation of financial reporting by that management. Audit Committee members should be selected and educated on this basis. Financial literacy is a low bar and is not enough. Educate yourself on how fraud happens if you are a director or audit committee member. If necessary, hire an expert to report to you individually or in closed session with the Audit Committee without any member of management present.

2. If your organization does not have an internal audit function, install one appropriate for your organization. The head of Internal Audit must report directly and confidentially to the Audit Committee and cannot be over-ridden by any company officer. If necessary, Internal Audit should report directly to the board.

3. The Audit Committee must approve the independence, budget, work-plan and succession of the head of Internal Audit. The board should direct the CEO and CFO to commit resources for further design and test of internal controls whenever necessary.

4. As a director, you are entitled to any piece of information and access to any personnel in fulfilling your duties under any circumstance. If any manager blocks you from doing your job, this is a red flag. Go on unscripted company tours unaccompanied by management to test for tone and culture whenever you can.

5. Direct management to conduct a survey on company culture, assisted by an independent firm, with results reported directly to the board. Act on the results. You may have a toxic workplace with undue influence, internal control override and bullying and not even know it.

6. The independent whistle-blowing hotline must have a protected mechanism for people to come forward. When fraud happens, fellow employees know and are your best source of defense. If employees do not have confidence they can come forward and have a proper investigation conducted, they won’t and fraud will fester. Whistleblowers can go to regulators directly (in the US) now and participate in a monetary reward. If they don’t have confidence in the hotline, they will quit, acquiesce or go directly to the regulator.

7. Direct independent advisors (consultants, and now auditors) to conduct a risk assessment of all management compensation packages to ensure compensation is not driving potential fraud, such as bonuses awarded on profit.

8. If any company officer is not 100% transparent with you, this is a red flag. You should meet in executive session without management in the room to discuss your concern, which is likely shared by other directors. If the CEO or CFO lack integrity, the tone at the top is broken and you have a serious problem. You do not need a reason to fire your CEO.

9. Your responsibility as a director is to direct if and when necessary. Legislation gives you this power but protocols enable it. If management has undue influence and keeps you at bay, your protocols are likely deficient. Boards, committees, chairs and directors all need terms of reference now. Don’t let management draft these important documents as they have an interest in not giving you the power you are entitled to by law. Draft your own protocols or have someone independent do it if you have a concern or want best practices.

10. Above all, be vigilant and assertive if or when necessary. No amount of compensation can ever make you whole for the reputational damage inflicted and protracted litigation that could follow allegations of fraud or other misfeasance for a company of which you are or were a director. The number one regret directors have is not speaking or acting when they could have or should have. Don’t let this happen to you and follow the above steps.

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Dr Richard Leblanc