Enhanced whistleblower provisions should make it easier for employees to report fraud
Ten years ago, corporate governance was still in the concept stage. There wasn’t much information available to the public about the way corporations were governed, and there were few regulations, websites or groups dealing with the topic on a daily basis.
Over the years, however, the notion of good corporate governance has taken an interesting turn. After a string of corporate failures that crippled the economy, it has become clear that governance matters. Here, we take a look at ten significant events that have changed the face of corporate governance.
Perhaps the most important development was the passage of Sarbanes-Oxley (SOX), which has significantly altered the corporate governance landscape. This regulation was born out of the collapse of Enron, WorldCom and Tyco, which exposed the poor accounting and pay practices that many companies were engaged in between 2000 and 2002.
Also known as the Public Company Accounting Reform and Investor Protection Act, the law was implemented to improve transparency and the due diligence process while setting new standards for public company boards, accounting firms, senior management and executives.
The statute requires companies to have robust internal control systems that can be built into their compliance processes to promote integrity and accuracy within their business operations.
2. The fall of Lehman Brothers
SOX may not have been the answer to the weak governance and compliance structures of many companies. When one-time financial powerhouse Lehman Brothers filed for Chapter 11 in 2008, it became clear that effective corporate governance measures were needed and regulatory intervention was not enough.
Many felt that the collapse of Lehman led to the financial crisis, as it marked the largest bankruptcy in US history. However, Lehman was part of a crescendo of corporate failures, including Fannie Mae, Freddie Mac, AIG, Bear Stearns, General Motors and Merrill Lynch, which contributed to the economic meltdown.
The corporate boards of these heavyweights were charged with having poor risk management and oversight procedures. Many critics argue that boards were asleep during this period, and that they failed to set the tone at the top and establish robust governance practices.
The corporate governance chaos that emerged from the economic meltdown led to the passage of even more legislation in the form of the Dodd-Frank Wall Street Reform and Consumer Protection Act. In the wake of the Lehman crisis and a culture of abusive financial services practices, regulators felt that corporations should be actively monitored by new governmental agencies in order to increase oversight and streamline the regulatory process.
Dodd-Frank was implemented in 2010 to force firms to restructure corporate governance measures in order to prevent another financial crisis. The challenge for many companies, however, was emerging from a crisis having to do more with a lack of resources.
The act has imposed burdens on many companies by requiring more disclosures about annual proxy statements and executive compensation, which has ushered in a new era in corporate governance. Now, after two years, Dodd-Frank’s effectiveness is in question.
4. Social media governance
The evolution of governance has had a twofold effect on the way companies relate to social media. On one hand, a lot of corporations have started integrating the use of Facebook and Twitter into their daily operations in an effort to interact more with customers and to communicate quickly to the public in order to restore public confidence.
On the other, websites such as Wikileaks have emerged which expose the unethical and improper behavior of corporate directors. This has had an impact on the way companies govern themselves and manage their reputations.
However, it is the promise of what social media can provide that makes it so significant for governance and compliance. Governance professionals have started analyzing and testing strategies to help deal with new media technologies.
Under the corporate governance umbrella, social media governance teams have been implemented to help companies stay ahead of compliance and disclosure threats. In the new regulatory environment, failure to implement effective social media policies, with adequate employee training, is now viewed as a breach of a board’s fiduciary duty to protect the corporation.
5. Say on pay
One of the biggest developments to come out of the financial crisis was shareholder scrutiny of executive compensation. Prior to 2007, executives were cashing out big bonuses while companies suffered major losses.
Stock options that allowed executives to reap massive payouts even if their own company was underperforming were highlighted as a concern. Executives seemed to enrich themselves no matter how their company’s stock performed. Regulators and Congress did not take this lightly.
In dealing with the inequities of executive pay, say on pay, another provision of Dodd-Frank, has proven to be a game-changer. This provision allows shareholders to keep an eye on executives’ paychecks by voting for or against their compensation plans at the company’s annual meeting. As the provision has gained momentum, companies have started realigning their pay packages in order to gain shareholder support.
Executives may have a long road ahead, as shareholders have shown that they can band together to reject hefty pay packages. Citigroup’s chief executive Vikram Pandit saw shareholders reject his $15 million pay package in April. At the financial giant’s meeting, about 55 percent of the shareholders either voted against the plan or abstained.
Such majority votes against compensation – which in this case included attractive packages for the bank’s four top executives as well as Pandit – are rare. This was the first time shareowners had rejected a compensation package at a major Wall Street bank, and going forward, it may be a new trend.
6. Protecting whistleblowers
While the first whistleblowing protections came out of SOX legislation, Dodd-Frank has expanded the provision with stronger measures to deal with retaliation against whistleblowers and financial incentives so employees won’t think twice about coming forward to report corporate malfeasance.
It has been approximately ten years since Cynthia Cooper, who formerly served as vice president of internal audit at WorldCom, exposed a $3.8 bn fraud that later became one of the largest accounting scandals in US history. Cooper was one of the first to really push the act of corporate whistleblowing into the limelight.
Following in her footsteps, Sherron Watkins, vice president of business development for Enron, uncovered a financial scandal that left the company with no other choice than to file for Chapter 11 bankruptcy. Enron quickly became one of a series of audit failures that had a profound impact on the US economy.
While some industry analysts still argue that Watkins’ move to anonymously inform Enron’s CEO via email about the company’s doctored financial statements should not be considered whistleblowing, only someone interested in ethical corporate behavior would have taken the risk to expose the fraud. Today, Dodd-Frank seeks to clarify what is considered whistleblowing. The SEC has moved the whole whistleblowing process online, so filing a claim can be done without much hassle.
At the same time, whistleblowers can bypass the company’s whistleblowing hotlines and report directly to the federal watchdog. With the agency also offering financial rewards for uncovering fraud, finding the courage to blow the whistle should be easier now than ever before.
7. Corporate social responsibility
Ten years ago, the concept of corporate citizenship barely existed. Now shareholder proposals requesting information about CSR efforts are among the most common actions filed during proxy season.
Interest in CSR and sustainability efforts has been growing for years, but now it is deeply embedded in the DNA of many businesses and has moved from a strategy that few knew about to one of the most sought-after initiatives at a company.
Corporations have found that in order to expand their businesses globally, they must make sure they respect and protect the communities and environments of the nations in which they want to locate new factories or subsidiaries.
The BP Deepwater Horizon oil spill that occurred in 2010 helped push CSR into the limelight. After the disaster, many risk management experts started questioning how seriously major companies take social responsibility.
Shareholders wanted to know whether or not companies were doing enough to avoid these kinds of accidents, and whether these risks were incorporated into the growth projections they were receiving.
The internal and external risks that resulted from the oil spill led to many companies starting to take CSR seriously. Many analysts wondered if BP had met its ethical obligations to protect the environment.
Other companies took heed of BP’s missteps and started pushing CSR initiatives even further. Over time, this has paved the way for a new type of disclosure known as integrated reporting that connects financial and non-financial reporting together.
Companies like United Technologies and American Electric Power have created reporting standards to improve transparency by including governance and compliance performance coupled with their financial information.
Due to the changing regulatory landscape and increasing urgency in the marketplace, CSR has become ever more important and has given rise to the new role of chief sustainability officer (CSO) at many corporations. Most CSOs are taken very seriously and have a seat at the executive table.
8. The rise of the FCPA
Enforcement of the Foreign Corrupt Practices Act (FCPA) has hit an all-time high. In 2008, the FCPA gained a lot of attention as Germany-based Siemens was found in violation and agreed to a settlement of $800 mn in DoJ and SEC financial penalties. It was then and is still the largest FCPA enforcement action.
In 2010, the SEC created a specialized unit to further enhance its enforcement of the FCPA and added Kara Novaco Brockmeyer to serve as head of its FCPA division. Brockmeyer is well known for leading the FCPA investigations of Halliburton, KBR, Technip and ENI.
According to the SEC’s website, there has been a spike in FCPA enforcement between 2002 and 2012, with major cases like Walmart, Alcatel-Lucent, BAE and Snamprogetti gaining a lot of attention after these companies allegedly made illicit payments. Settlements have increased, and stepped-up enforcement will only add to the number of cases and fines.
With regulators turning more attention to international bribery, companies have been forced to enhance their compliance measures overseas. They have had to put more effort into understanding laws in the different nations in which they do business and creating internal controls to abide by the FCPA’s new and tougher standards.
9. Women on boards
Ten years ago, a woman serving as a corporate director was not the norm. While women are still greatly outnumbered by men on boards today, over the past three years many advocacy groups have been pushing for more women directors to balance out the all-male boardroom.
Corporate governance experts have claimed that having more women directors will contribute to better transparency and accountability practices in the boardroom. Some European nations feel so strongly about this that they have been imposing mandatory quotas for women on boards.
By contrast, earlier this year, GMI released a report that says the presence of women on US boards only increased by 0.5 percent from 2009 to 2011 and reached a total of 12.6 percent this year, well below the figures for the Nordic countries, Canada, Australia and France.
While over 70 percent of US boards have at least one female director, only 10 percent have three or more women. Women make up only 2 percent of board chairs. Experts believe future improvement of these numbers will change the governance landscape.
10. ‘Shareholder spring’ activism and protests
Shareholder activism is growing on a number of fronts. The Occupy Wall Street movement has continued massive outdoor protests and has inspired an offshoot entity called 99 Percent Power that is really putting some major companies’ risk management and corporate governance strategies to the test.
The group is showing up at the annual meetings of corporations, causing confusion and pushing governance reforms. The movement made its debut at Wells Fargo’s annual meeting, which according to the Huffington Post spiraled out of control and was unexpectedly halted after demonstrators claimed proxy votes might be invalid because the bank had acted illegally in prohibiting some shareholders from attending the meeting.
The fact that these movements can have an impact on annual meetings is not a good thing for the corporate secretaries and general counsel who spend a significant amount of time planning and preparing them.
Few companies can afford to ignore the prospect of annual meeting disruptions – however, shareholders and labor groups are more willing to adapt to some of these disruptive measures due to frustrations with executives’ unwillingness to adjust certain polices.
Governance experts are wondering if these protests are just a one-year phenomenon – or are they a trend that will continue into 2013?
This article originally appeared in Corporate Secretary, IR magazine's sister publication.