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

Anthony Fitzsimmons is Chairman of Reputability LLP and, with the late Derek Atkins, author of “Rethinking Reputational Risk: How to Manage the Risks that can Ruin Your Business, Your Reputation and You”

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


Anthony Fitzsimmons is Chairman of Reputability LLP and, with the late Derek Atkins, author of “Rethinking Reputational Risk: How to Manage the Risks that can Ruin Your Business, Your Reputation and You”

Learning from mistakes

"Central banks don't like analysing their past mistakes but should." That's what Tim Geithner, former US Treasury Secretary, told the FT's Martin Wolf.
 

Analysing mistakes is one of the best ways of learning from experience for everyone, not just central banks.  But it isn't as easy as it sounds.
 

When a big mistake has a bad outcome, the mistake becomes public knowledge and there is often a post-mortem.  As Anthony Hilton has sagely observed, post mortems are often inadequate: 

"...[I]nquiries focus on the processes within an organisation until they find some hapless individual or group who departed from the manual. Identifying that person becomes a proxy for solving the problem.

Such inquiries are often superficially impressive but fail to deliver what is needed because they fall short on psychology. It is not what people did but why they did it that matters. Too few inquiries actually unpeel the layers of a problem to get to its root; to pinpoint what it was about the firm’s culture — the incentives, the regulatory environment — which caused a normal employee to engage in rogue behaviour."

But the vast majority of mistakes don't have bad or obvious outcomes and can easily be kept quiet.  This may be because someone doesn't wish to acknowledge having made a mistake.  Perhaps they fear the reaction of their boss.  Or they may have have a boss who doesn't want to hear about problems as long as the problem is solved.   These and other behavioural risks drive underground the knowledge of mistakes without obvious consequences.  They stay there, unacknowledged and unanalysed.  The organisation learns nothing.  

It all seems very comfortable until something big goes wrong and it is discovered that the organisation has known about the problem for years and done nothing.  Often the problem is well known below a certain level but a 'risk glass ceiling' keeps it hidden from leaders.  So the board thinks all is well until it discovers that there is a huge unknown known - important stuff they really want to know but can't find out.
 

When things eventually come into the open, and they usually do, the organisation is seen as dysfunctional, an organisation that doesn't learn from its own mistakes.  It loses its reputation and heads roll.  Justifiably.
 

The challenge for business leaders is to embed a learning culture through out the organisation and its supply chain.
 

This isn't pie in the sky.  It can be done.  Aviators, including the entire aviation supply chain, work hard at it. It's no accident that flying has become so safe.

With good leadership, any organisation can do it.  Even a Central Bank.

Anthony Fitzsimmons

Reputability LLP

London

Anthony Fitzsimmons is Chairman of Reputability LLP and, with the late Derek Atkins, author of “Rethinking Reputational Risk: How to Manage the Risks that can Ruin Your Business, Your Reputation and You”

Caffè Nero Blackened

One of Caffè Nero's customers, Steve Pottinger, has written to return his loyalty card.  He complains of their failure to pay any corporation tax on their profits.  "I'm aware that what you do is perfectly legal... but at a time of austerity when vital services face cutbacks, it sticks in the craw.  Loyalty cuts both ways. But you seem to have a disconnect when it comes to your responsibilities to paying your dues."

The story is that whilst Caffè Nero made £21m profit last year, it didn't pay any corporation tax.  At least the previous year, when it paid no corporation tax on almost £40m profit, the reason seems to have had to do with tax-deductible interest the company pays to its Isle of Man parent company on debt used to buy the business.  There is no suggestion this is illegal; but many see it as amoral.  The company has declined to comment on the exact explanation.

Whatever the truth, Mr Pottinger's letter has gone viral and Caffè Nero faces a Starbucks moment because at least Costa provides a decent alternative cup of coffee from outlets that regularly advertise their corporation tax paying virtues.

The episode illustrates two important points.

The first is how the internet has disestablished the establishment.  Nowadays if you have a grievance and know how to catch the public mood, it is easy to coalesce large numbers of fellow-thinkers in a way that was unthinkable before the internet.  Starbucks and Maclaren (the buggy-makers) and United Airlines are among the many who have learnt this to their cost. 

Second, if an individual's issue fires the public imagination to damage a company's reputation, it ceases to be the individual's problem and becomes the company's.  This was rapidly appreciated by United, who responded well to Dave Carroll's viral video.  Maclaren also responded nimbly.  Starbucks eventually recognised that the way it arranges its tax affairs can affect its business adversely and now pays some UK corporation tax.

No doubt it will not be long before Caffè Nero too wakes up and smells the coffee.

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

The Co-op: Don't Blame the Mutual Model

The unfolding Co-op debacle has encouraged some commentators to question the viability of the mutual model in the 21st century. The model may have its disadvantages but there are notable examples of highly successful mutuals in the financial and retail sectors where the Co-op operates.

 Sir Christopher Kelly's report published yesterday confirms the media views that the Co-op was brought to its knees by a long list of mishaps, including:

• The merger with the Britannia Building Society in 2009.
• Failure by the Bank after the merger to plan and manage capital adequately.
• Fundamental weaknesses in the governance and management of risk.
• Material capability gaps, leading to a serious mismatch between aspirations and ability to deliver.
• Past mis-selling of payment protection insurance (PPI).
• A flawed culture.
• A system of governance which led to serious failures of oversight. 

But what are the root causes of these lamentable failures?

The root causes are the familiar 'underlying causes' – what we now call Behavioural and Organisational Risks - identified in 'Roads to Ruin', the Cass Business School report for Airmic and our own report 'Deconstructing failure - Insights for boards'.  They are depressingly familiar and include:

• Lack of board skill  and experience
• Lack of strategy where one was needed
• Lack of board understanding of reputational risk
• Board unaware of important information
• Board risk blindness and groupthink
• Unwillingness and inability of Non-Executive Directors to stand up to Executives 
• Failed board leadership on ethos and culture 
• Culture that delayed bad news and discouraged challenge 
• Risks from poorly understood complexity
• Failed change management
• Risks from inappropriate incentives

Rather than blaming the mutual model, the challenge should be to the conventional wisdom of the Three Lines of Defence risk management approach, which was not questioned by Sir Christopher no doubt on the basis that if it is good enough for the Basel Committee on Banking Supervision, it is good enough for him.

Unfortunately, as we have previously explained, the Three Lines of Defence model is flawed.

As a process it is conceptually sound, and its name sounds reassuring - as did the name of the Maginot Line. But it assumes that risk management has the tools, and risk managers the authority, to capture and deal with behavioural and organisational risks.

This assumption is wrong, whether those risks are at or below board level.  Classical risk management does not have the tools systematically to find behavioural risks; and risk managers do not have the status to challenge their superiors from whom most of these risks ultimately emanate.

The problem is the old one. The board sits at the apex of a risk management structure, but who is able to manage risks that emanate from the board itself? Or as the Roman satirist Juvenal put it, “Who is guarding the guards?”

In a regulated environment, regulators are one of the few who can ensure that boards get an outside view on the risks they create.  It is reassuring to see two of the UK's most important business regulators taking up the challenge.
 
The Financial Reporting Council has tackled the issue. Its guidance, effectively directing boards to tackle behavioural and organisational risks, is expected to come into force on 1 October.  The Bank of England/PRA is not far behind.  This is nimble work for which the FRC and PRA should be congratulated.


Professor Derek Atkins
Anthony Fitzsimmons
Reputability LLP
London


Anthony Fitzsimmons is Chairman of Reputability LLP and, with the late Derek Atkins, author of “Rethinking Reputational Risk: How to Manage the Risks that can Ruin Your Business, Your Reputation and You”

Imminent FRC Rulings on Behavioural and Organisational Risks

The banking crisis probably reflects the largest ever failure of risk management and internal control by boards, risk managers, internal auditors and regulators.  It was system-wide and its root causes remain largely outside risk management.

Risk management failed because of a major gap in the science of risk management, first identified in 2011, in 'Roads to Ruin' the Cass Business School report for Airmic.   Two of the four authors are partners in  Reputability.

The report identified and classified a series of previously unrecognised risks from individual and collective human behaviour at all levels of organisations, from the bottom to the very top including boards.  We now call these risks 'behavioural' and 'organisational' risks.

Our own report, 'Deconstructing failure - Insights for boards' subsequently extended the research into the role of boards in corporate failure.  The findings can be summarised in the bar chart below which shows the frequency with which we identified various root causes across 41 case studies.

Source: 'Deconstructing failure - Insights for boards'. © Reputability 2013

Last November, we reported that the Financial Reporting Council is tackling this dangerous but under-recognised family of risks head-on.  You can read the background here.

The FRC's timetable is now becoming clear.  As a result, it is now a priority for boards to gain a systematic understanding of behavioural and organisational risks.

As we explained last November the FRC has two regulatory actions in the pipeline.

The first is the ‘Draft Guidance on the Strategic Report’.  A revision to the Companies Act 2006 requires boards to disclose, in the Annual Report, their company's ‘Principal Risks’.  The FRC's draft guidance on how to do this states:

"Principal risks should be disclosed and described irrespective of how they are classified or whether they result from strategic decisions, operations, organisation or behaviour, or from external factors over which the board may have little or no direct control." (underlining added)

Many of the Principal Risks to a company have their origins in the way its people, at all levels, behave individually and in the context of the organisation in which they work, though these origins often remain unrecognised until it is too late.  Boards cannot fulfil this duty without an adequate understanding of behavioural and organisational risks.

This guidance, which seems set to be issued in September, is expected to apply to accounting periods beginning on or after 1 October 2014.

The second is the FRC’s ‘Draft Guidance on Risk Management, Internal Control and the Going Concern Basis of Accounting’. This revises the old so-called ‘Turnbull’ Guidance and implements the Sharman Report on the ‘going concern’ basis of accounting.

Laced with dozens of practical questions for boards to ask themselves about behavioural and organisational risks, the draft Guidance on Risk Management is designed to help boards oversee the practicalities of managing such risks below them and to recognise the issues that surround them.  Here too, boards cannot fulfil their duties without an adequate understanding of behavioural and organisational risks.

This guidance too seems set to be issued in September, and is expected to apply to accounting periods beginning on or after 1 October 2014.

So what needs to be done?  The first requirement is for boards to gain adequate knowledge to understand and supervise these newly recognised risks.  The shape of the solution comes from the Corporate Governance Code, which requires boards regularly to ‘update and refresh their skills and knowledge’.   

The first step is therefore for Chairmen and Company Secretaries to commission tailored board education about behavioural and organisational risks and their relationship with reputational damage.  Everything else flows from that.

Anthony Fitzsimmons

Reputability LLP

London

www.reputability.co.uk

PR - How not to improve your Reputation!

The success of the PR industry has recently been measured, and some surprising findings have emerged.

YouGov, who carried out the research found that the PR industry in the UK is forecast to be worth £9.62 billion, that's 28% more than in 2011, when the research was last carried out. There are now 62,000 employees in the industry.

YouGov also reported that 'Overall, PR professionals are confident of continuing growth in revenue and headcount'.

It is all the more surprising, perhaps, to note that the incidence and scale of corporate crises has continued undiminished over this PR golden age. Could it be that there is little correlation between an increased spend on communications and a reduction in business catastrophes? Could it be that the money that is being pumped into Public Relations is a waste of time and resources? Is it that professional communicators cannot prevent crises? Perhaps they miss the warning signs altogether? Or are they aware of the behavioural and organisational complexities which underpin crises, but are powerless to influence them?

Reputability's research, 'Deconstructing failure - Insights for boards', demonstrates how often the root cause of most reputation-damaging activity stems from the organisation's board and, to date, few PR professionals are represented here. Equally worrying is the fact that most Risk Managers are also too junior to have board positions. The combined absence of these two key functions contributes to the information 'glass ceiling' where boards simply miss out on knowing what is actually happening on a day to day basis in their companies.

My own view about the growth and buoyancy of Public Relations is that the greatest impact made in recent times has been as a large contributor to the excellent marketing seen in most organisations today. But even this can be seen as a double-edged sword. In fact, the very success of PR and marketing can raise customer expectations to such a level that when the delivery of the product or service proves to be distinctly underwhelming there is a consequent rise in customer complaints and a massive dent in corporate reputation.

PR can never be a substitute for sound policy-making and good governance. Those companies which seek to exclude communications professionals from decision-making, and view the PR function merely as a convenient mechanism for glossing the corporate reputation are likely to receive a very rude awakening.

Jane Howard FCIPR
Reputability LLP
London
www.reputability.co.uk