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Reputability LLP are pioneers and leaders in the field of reputational risk. We help business leaders to find the widespread but hidden behavioural risks and organisational risks that regularly cause reputational disasters. Here are our thoughts, and the thoughts of our guest bloggers, on some recent stories which have captured our attention. We are always interested to know what you think too.

Monday, 4 August 2014

Reporting on Important Risks - Guidance for Chairmen and Boards

The Financial Reporting Council's latest guidance on the reporting of important risks has now been published.  In a nutshell, boards are required to report 'principal risks' that have their origins in 'behaviour or organisation', what we call behavioural and organisational risks.  This new recommendation effectively recognises our conclusion, that there is a hole in the 'Three Lines of Defence' doctrine that underlies most current risk analysis and reporting.

Behavioural and organisational risks are important causes of reputational damage and of many better-recognised risks. However, boards cannot properly report on 'principal risks' until they have systematically identified and evaluated both the range of behavioural and organisational risks at work in the company and the extent to which they may give rise to principal risks including reputational hazard.

We have written about the practical implications for boards, chairmen and company secretaries, for Governance, the authoritative publication on international corporate governance.

You can find our article here.

Anthony Fitzsimmons
Reputability LLP
London
www.reputability.co.uk






Tuesday, 24 June 2014

Can the NHS embrace behavioural and organisational risk?

A year ago, Mike Bell wrote about the safety culture in civil aviation which has made flying so safe.  He wrote:
"There are two principal factors involved in aviation’s success: 

  • There is an independent regulator, with a clearly defined role, expert staff, accountable to parliament, and funded by those it regulates; and 
  • There is a culture of openness, with timely and honest reporting of all untoward occurrences whether or not they cause harm and widespread dissemination of the lessons to be learnt. "
The UK's National Health Service ("NHS") now appears to be moving in that direction, with the Secretary of State, Jeremy Hunt, announcing "unprecedented hospital data release which aims to ensure NHS remains a world leader on safety" and a "new safety drive with ambition to save up to 6,000 lives and halve avoidable harm".

The move was been prompted by the Report of Sir Robert Francis QC into the Mid-Staffordshire Hospital Trust debacle with support from the Clinical Human Factors Group which was founded by a commercial airline pilot following the death of his wife from a clinical accident.

The aviation sector has long recognised the crucial role of reducing behavioural and organisational risks - what the industry calls "Human factors".  The industry recognises that special measures have to be taken to ensure that all mistakes, including those without adverse consequences, are reported.  Only then can they be analysed to their real root causes and lessons learned and disseminated widely.

Such a system is intrinsically fragile because it takes very little for the supply of reports of mistakes to dry up.  People will not own up to their own mistakes if they suspect they may be treated unfairly.  They will not tell a superior that they may be making a mistake unless they are confident that their honest view will not be met with disdain or aggression.  They will not report what they believe are unacceptable practices if they fear retribution or if they think no action will be taken.  Fear of litigation or prosecution may drive mistakes underground.  And if hospital manager body language gives the impression that they do not really want to learn about and from all mishaps, however minor in consequences, the system will also be undermined.

It is therefore important that Sir Robert is to chair the independent review into what further action is necessary to protect NHS workers who speak out in the public interest and help to create the kind of open culture that is needed to ensure safe care for patients.

The NHS should be congratulated in trying to move in the right direction in dealing with the behavioural and organisational risks that have bedevilled patient safety for decades.  But there remains much work to be done, and to be successful it will need a sea change in the attitudes of politicians as well as by those who run the NHS.

Anthony Fitzsimmons
Reputability LLP
London
www.reputability.co.uk



Monday, 23 June 2014

Character, Trustworthiness and Incentives

Charlie Munger isn't as well known as Warren Buffett, but he is Vice Chairman at Berkshire Hathaway and, among other interests, a business philosopher.

A recent paper from the Rock Center for Corporate Governance collected Munger's ideas on corporate governance.  His thinking is worth summarising.

Munger starts from the premise that companies need a governance system because individuals working for a firm are inevitably self-interested and may therefore tend to act in their own interests rather than those of the firm.  To anyone with a background in behavioural risk that is a good place to start.

Having noted the current trend for ever more control systems, Munger rows in the opposite direction.  He advocates a governance system based on "a seamless web of deserved trust".  This requires recruitment for character, something that was also emphasised in 'Leadership on Trial', a research report from the Richard Ivey School of Business in Canada. 
"Good character is very efficient.  If you can trust people, your system can be way simpler.  There's enormous efficiency in good character and dis-efficiency in bad character."
But can you trust the people?  That, as Munger acknowledges is a key question.  You can only rely on a trust-based system to the extent that you can rely on the people not to put their self-interest above the corporate interest.

Munger sees the lynchpin as a high calibre CEO who can be trusted to put his firm above himself.  As the researchers observe, the trust based systems that Munger uses as his examples, such as James Sinegal, the founder and former CEO of Costco, are founder-led organisations.  This is an important observation.  Founders of integrity who understand the value of integrity have the power to recruit others of integrity.

Warren Buffett unsurprisingly has a similar approach to hiring CEOs.
“Somebody once said that in looking for people to hire, you look for three qualities: integrity, intelligence and energy. And if they don’t have the first, the other two will kill you. You think about it; it’s true. If you hire someone without integrity, you really want them to be dumb and lazy.”
A different basis for a trust-based system is recognised in a recent academic study of the community who trade at Lloyd's, the insurance market.  

Lloyd's is ultimately a community of people who, by and large, like the work they do, are proud to be working in Lloyd's and have much of their social life connected to Lloyd's.  Participants know that the long-term well-being of Lloyd's is vital to their future well-being, both financially and socially.  And they know that their own social position in Lloyd's depends on adhering to widely accepted standards of behaviour.  This state of affairs gives participants strong incentives to good behaviour and a strong self-interest in the future well-being of Lloyd's.  Munger would probably recognise that strongly aligning personal self-interest with the long-term interests of Lloyd's should encourage trustworthy behaviour towards Lloyd's within Lloyd's.  (Afficionados of Lloyd's structure will recognise that there is another axis, the relationship between individuals who trade at Lloyd's and their employers.)

Add recruitment for character, often at a young age, and a reinforced memory of near-death in the early 1990s and you have a powerful combination of history, culture and incentives that should help to keep behaviour within widely acceptable limits. 

But the world of companies that have emerged from their founders' aura onto competitive stock markets seems different.  CEOs are under many short-term pressures.   These are amplified by the 'Agency' issue and the fact that a CEO's expectancy of tenure is a small number of years.  It is much harder to remain a paragon under such conditions.

Anthony Fitzsimmons 
Reputability LLP
London
www.reputability.co.uk



Wednesday, 11 June 2014

New FRC Guidance on Reporting Behavioural and Organisational Risks

On 9 June 2014 the Financial Reporting Council published new guidance as to boards' reporting important behavioural, organisational and reputational risks in the annual Strategy Report of companies it regulates.  The guidance effectively comes into force immediately.  You can find background here.

The FRC's "Guidance on the Strategic Report" ("the Guidance") provides:
"The Strategic Report should include a description of the principal risks and uncertainties facing the entity together with an explanation of how they are managed or mitigated."
This explicitly includes risks with their origins in behaviour and organisation and risks to reputation.

Implications

The 'principal risks' which boards should now disclose and describe are defined to include risks and risk combinations that could seriously affect the performance, future prospects, reputation or business model of the entity.  Boards should disclose principal risks with their origins in various sources including behaviour or organisation.  This ruling encourages boards to fix the gap in current risk analysis practice that leaves behavioural and organisatinal risks unrecognised and therefore unmanaged.

It follows that boards should disclose and describe behavioural and organisational risks that could cause serious reputational or other damage were they to materialise as well as how those risks are mitigated.  Descriptions should be sufficiently specific that a shareholder can understand their potential impact and any mitigation applied.

Current analytical approaches identify some reputational risks but the most widely used are unsystematic and miss important areas of reputational risk.  There are no widely used techniques to identify behavioural and organisational risks.  Few even endeavour systematically identify the reputational and other consequences of behavioural and organisational risks.  These gaps must be filled if boards are to be able to follow this FRC guidance.

Given that specific guidance on reporting such risks has been given, there may be legal consequences for boards that report inadequately.  We would hope that courts will in practice allow boards a reasonable period of grace to bring behavioural, organisational and reputational risks under systematic management.

Since the FRC's revised draft guidance to boards on risk, including behavioural and organisational risks, is already available, we believe that boards should start work in this area without delay.

Action for Chairmen and Company Secretaries

Boards cannot report on these risks until they have systematically identified and evaluated behavioural, organisational and reputational risks. 

However, boards cannot insightfully specify the work they require to be done, let alone monitor its progress and consider its conclusions or report on 'principal risks', unless they understand the recently identified family of behavioural and organisational risks.

This is an exceptionally acute problem.  One of the findings of 'Roads to Ruin' was that even classically trained risk professionals lack both the necessary skills and the authority needed to find risks of these kinds.  The most astute Chief Risk Officers are starting to tackle the issue, but many face difficulties in engaging their boards and gaining their authority.  Some also see personal risks in raising the subject with their boards because many of these risks have their root cause at board level.  This confirms the conclusion in 'Roads to Ruin' that board leadership is essential to bringing this family of risks under control within organisations.

How can boards gain adequate knowledge to understand and deal with these newly recognised risks?  The first step is for Chairmen and Company Secretaries to commission tailored board education about behavioural and organisational risks and their relationship with reputational damage.

Armed with that education, boards can re-brief and empower their risk and internal audit teams.  The aim will be to put boards into a position where they can meet both the guidance on risk disclosure and the forthcoming FRC guidance on the management of behavioural and organisational risks.

Boards that initiate prompt action should have little difficulty in meeting the new guidance.

Anthony Fitzsimmons
Reputability LLP
London

Saturday, 7 June 2014

Dysfunction at the heart of government?

Giles Wilkes spent four years as a Special Adviser in Vince Cable's Department for Business, Innovation and Skills.  He has written about his experience rather as the proverbial Martian might report on a visit to Planet Earth 

He makes five dispiriting observations.
  • There is 'no such thing as HM Government'; it is a 'ship without a bridge', let alone a captain.  He sees the Government as consisting of about 20 departments each fighting for its own agenda, each led by politician who was selected for his success in internecine strife.  The result is a silent kind of dysfunctionality characterised not by open argument but by the sullen silence so characteristic of teenage boys.
  • Ministerial Private Secretaries are debonair, politically savvy fixers, the best of whom breezily fudge discord so that it gains the appearance of agreement.
  • Politicians - and perhaps Civil Service leaders, Wilkes is unclear here - usually start ignorant, gaining their knowledge of important subjects from lobbyists.  This is a dangerous way to make policy.  A little learning is a dangerous basis for policymaking especially if its source is a combination of dogma and one or more propagandists, or lobbyists as Wilkes politely calls them.
  • The Treasury has abolished the use of money as a store of value or as a unit of exchange.  Thus unspent money cannot be saved for use next year but disappears at the end of the financial year unless spent.  And money assigned to one department  for one purpose cannot be used for another purpose let alone used by another department who might achieve that purpose better.  This creates bizarre incentives.
  • The heart of government regularly trades policy in a way for which is often despised others, such as the American Congress, Senate and White House.  Mr Wilkes proudly records having traded a regulatory issue about taxis for an unrelated benefit concerning oil from the tar sands of Alberta.
Through 'Roads to Ruin', the Cass Business School report for Airmic and our extension of that research, 'Deconstructing failure', we have identified a series of behavioural and organisational risks that apply to all organisations run by humans, but our sample consisted in the main of commercial organisations.  How do these apply to Government?

If Mr Wilkes' observation of his time in Government is a fair view, we can see many of these potentially catastrophic risks manifested in his snapshot, for example risks from:-
  •  A lack of effective overall leadership
  • A complex and ungoverned structure with a lack of join-up across the whole
  • Incentives that drive perverse, potentially dangerous or wasteful behaviour
  • A lack of critical skills and knowledge among leaders who need them
  • A culture of internecine strife that stifles internal communication and learning from mistakes
  • A series of dominant leaders whose characters and behaviour discourage co-operation
  • The consequent dysfunctionality
  • Blindness to the risks inherent in such a system, such as the risks from selective briefing by protagonists as opposed to systematic education by disinterested professionals and many more
Unfortunately, risks such as these remain unrecognised, let alone managed, in the Civil Service.  This is made worse because the Civil Service resolutely resists revising its bible on risk management the Orange Book to take account the recently recognised class of 'behavioural' and 'organisational' risks.

And as 'The Blunders of our Governments' by Professors King and Crewe so dismally illustrates, these potentially lethal risks regularly materialise to lose huge amounts of taxpayers' money.

Anthony Fitzsimmons
Reputability LLP
London
www.reputability.co.uk

Thursday, 29 May 2014

Bribery and Boards

No-one doubts the GSK board had excellent ethics and good intentions, or that the company has an excellent set of values, but allegations reported in the Financial Times make alarming reading.

On 14 May, the FT reported:
"Police at the [Chinese] Ministry of Public Security said 46 suspects at GSK’s Chinese subsidiary had been identified as part of a “complete bribery chain” that funnelled money to hospitals, doctors and government officials between 2009 and 2012. Mark Reilly, a Briton who was head of the unit, ordered subordinates to offer the illegal payments, they said." 
On 27 May, the Serious Fraud Office in London “opened a formal criminal investigation into the group’s commercial practices”

The next day, the FT reported that GSK salesmen were demanding reimbursement of ‘bribes’ they had financed on GSK's behalf.

This isn't the first time GSK has been in trouble over sales practices.  In 2012 the company was fined $3 billion in the USA after admitting marketing medicines beyond their authorised uses, a case that also revealed "lavish junkets" for doctors.  At the time Sir Andrew Witty, the Chief Executive, said that the charges related to "a different era" at GSK and that he "had since taken remedial measures, including axeing all bonuses linked to prescription sales".

One likely root cause of the  problem is hinted at by Sir Andrew.  Late last year, he announced another overhaul of marketing practices, including an end to target-based pay for sales representatives, presumably those that weren't actually ended in 2012.  Those pesky incentives to meet sales targets can easily produce undesirable behaviour, as UK banks and energy companies know all too well from their mis-selling experiences.

But there is a deeper issue: the fact that the well-intentioned board clearly did not know what was actually going on in their company.  This is a widespread problem, about which we have written previously.  The danger is that boards live in a rose-tinted bubble divorced from reality.  For a variety of reasons they are too often the last to realise that something is seriously amiss even when there are people below them who are aware of the problem.

These are but two of the family of behavioural and organisational risks that afflict all organisations.  Regulators are beginning to insist that they are tackled before they cause harm.  This is no small challenge but there are practical  solutions.

Anthony Fitzsimmons
Reputability LLP
London
www.reputability.co.uk





Wednesday, 21 May 2014

Trust

Trust is crucial within boards, between leaders and 'followers' and between the company and its stakeholders. Loss of trust can be disastrous. It can cause severe reputational damage.

But too much of the wrong kind of trust - for example unquestioning trust - can be dangerous.  Amongst other issues, it can cause complacency, ineffective NEDs, dazzled subordinates, groupthink and risk blindness.  All are serious behavioural and organisational risks that have regularly led to disaster.

Leaders should aspire to trust of a mutual kind that will, for example, listen to and digest other perspectives and welcome perceptive questioning, constructive criticism and robust challenge - not to mention unwelcome news.

Anthony Fitzsimmons
Reputability LLP
London
www.reputability.co.uk