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What a Board Expects from Management, and What Management Expects from a Board

Jan 27

Posted in Board-CEO Relations, Relationships and Communication | Comments Off on What a Board Expects from Management, and What Management Expects from a Board |

I recently trained a group of directors and CEOs from the banking and agricultural sectors in Texas and Arizona. We discussed mutual expectations on the part of the board and management. The following represents the output of these discussions, which could apply to a variety of boards.

What the Board Expects from Management

Here is what a good board is entitled to expect from management, in no particular order:

1.         No Surprises or Spin

There should be no surprises for a board. CEOs and senior management need to tell the board the true state of affairs, without the “spin.” Directors know when they are not getting the “real deal” from management. If the CEO manages the board, or holds cards too close to the vest, this is a problem for a board.

2.         Bad News Must Rise

The board needs to be the first to know when need be, not the last. Management needs to have systems, processes and incentives that promote full transparency and reporting, right up to the board and its committees. The board needs to be assured of this.

3.         Deep Expertise in the Business

The board wants to see expertise across the full management bench, with no gaps. A problem arises when the board sees a weakness with which the CEO does not agree. Some CEOs have had trouble adjusting to a “new normal” of boards opining on C-level positions and oversight functions (e.g., internal audit). If a CEO does not accede to a board preference, this will be a problem.

4.         Visibility of Management Thinking

The board should see proposed options from management, including what was rejected and why. Management’s thinking and assumptions need to be fully transparent to the board and open to critique. A red flag occurs when management’s thinking is not visible.

5.         Full Information

There should be no information funneling or blockage of any sort. The board is entitled to any piece of information or access to any personnel to do its job. Management should support full information flow, including information that does not support management’s positions.

What Management Expects from the Board

Management, in turn, has expectations of the board. They are:

1.         Candor

Directors need to be candid and speak their mind in board meetings, not have hidden agendas, nor speak inconsistently offline. If directors are inconsistent, it can cause a schism in board-management relations and trust. The board should speak with one voice and not send mixed messages to management.

2.         Integrity and Independence

Directors cannot be self-interested, nor use their position to self-deal. If a director promotes management capture to occur by currying favor with management, this will undermine management-board relations. Management is entitled to directors preserving their independence and not placing management in compromising positions.

3.         Direction

A good –and smart– CEO wants a strong board. A board of directors should direct management as and when necessary to prevent the CEO from making that one big mistake. The board should be in charge at all times and management should know this.

4.         React in a Measured Way

If management is to be transparent, the board needs to react proportionately. If there are leaks, or the board is constantly critical, the CEO will not bring ideas or concepts, or his or her real thinking to the board, but only a polished crystal ball for board approval. This tone will cascade to senior management. This could cause governance failure as the board is shut out.

5.         Trust and Confidence

Management gets demoralized when they feel the board lacks trust or confidence in them.

If a board does not have trust or confidence in its CEO, it has the wrong CEO. CEOs may react when this happens – “either you have confidence in me or fire me” for example. If the board as a whole lacks confidence in the CEO, the CEO needs to go. If only a small minority of directors do and cause dysfunction as a result, these directors need to go.

6.         Knowledge of the Business

Management expects directors to invest the time to understand the business fully, especially if they are not from the sector. Otherwise, these directors will be of limited use to management strategically and their opinions will not be taken seriously nor be credible. Management gets frustrated by dated, legacy directors who have outlived their usefulness. Boards should know when this happens.

7.         Meeting Preparation

Management expects each director to arrive fully briefed and ready to discuss and should be able to rely on this. Otherwise, the engagement level degrades and gets sidetracked. The chair of the board should set these expectations and lead by example.

8.         Asking Good Questions

Lastly, management knows that the best directors ask the best questions that cause them to really think. If directors have a hobbyhorse, or ask inane questions in the eyes of others around the board-table, their credibility will suffer. These directors should go.

Many of the above topics are not visible from outside a boardroom. Nor can they be, for the most part, regulated. But they all contribute to the quality of the board-management relationship, board decision-making, and whether the organization is well governed.

20 Questions For New Directors Asked to Join a Not-for-Profit Board

Jan 1

Posted in Not-for-Profit Board of Directors | Comments Off on 20 Questions For New Directors Asked to Join a Not-for-Profit Board |

A female bank vice president was asked to join a not-for-profit (NFP) board and asked me what questions she should ask, before she joined. I shared what follows with her, and I reproduced it below and amended it.

Here are the questions I would ask before joining a NFP board. Some or many of them can apply to other types of boards. It is important to scrutinize the organization for professionalism and fit, particularly for NFPs where resources can be stretched, as your reputation and even financial assets may be at risk. Many directors I interview, when I ask for their greatest regret, they say not firing the CEO earlier, and joining the wrong board.

These questions try to address the downside of joining the wrong board. Here they are:

1. Do you have an inner passion for what the organization does and stands for (its vision, mission and values), and whom it serves? Can you make a solid contribution to the strategy of the organization and its performance?

2. For Director & Officer insurance, ask to see the policy and have it independently reviewed, including scope and depth of coverage, exclusions and indemnities. Assume the worst-case scenario, such as fraud, accidents, harm to a beneficiary of the NFP (e.g., student, children, patients, etc.), property destruction, harassment, or a completely unanticipated risk, including injury or death.?? Make sure you are appropriately covered, including advancement of legal expenses.

3. Ask about donor stewardship assurance, conflicts of interest, internal policies governing self-dealing, asset treatment, ethical compliance, expense reports for staff, gift policy, and reputational risk.?? Specifically, ask to see these policies and reporting as part of your “ask” binder of materials.

4. Ask to see all important reporting (financial, budgets, by-laws, strategic, risk, operations, resource allocation for programs and administration, beneficiaries / stakeholders, governance) as part of your consideration.?? Be prepared to sign a confidentiality agreement if you are asked.

5. Talk to current and past directors if possible (including CEO/Executive Director).?? Talk especially to former directors, if you can. Look at the tenure of management, staff and directors too. Prolonged tenure can indicate entrenchment and undue influence. Take a tour of key facilities as talks progress, to see the culture.

6. Who chairs the board and the audit committee? What is his or her leadership style, commitment to effective governance?

7. What are the board dynamics and board-staff relations like? Are there factions or control, by a particular donor, management or other stakeholder for example??? Ask to see a board meeting in action if or when it comes close to the “ask” stage.

8. What are your roles, responsibilities and expectations, both generally (as a director), but specifically you? Are donations or fundraising expected? If so, what are expectations, so you know what you are signing on to.?? Be as explicit as possible here, tactfully and diplomatically. But don’t not ask.

9. What competencies, skills and contacts do you possess that would contribute to your effectiveness as a director, that this NFP board is looking to you for?  What contribution to you think you could make?

10. Do you understand fully, or have a capacity to understand fully within short order, the revenue model and the financial accounting and measurement issues involved in this NFP? Staff will make choices on accounting policies for making estimates, and you need to understand how and why, and to detect potential manipulation. (Assume fraud may occur.)

11. Is your directorship tied to your professional employment at your home firm??? Do you have consent from your home firm on your end, if it is needed? You should obtain this if need be, as a case can be made for your professional development and relational enhancement. Tell your firm the name of the prospective NFP, as your identify and firm name (and its reputation) may be involved. Consent however should not unreasonably be withheld. Make the case for professional development, networking, learning, brand and reputation.

12. How many board and committee meetings are there? Length? Location? Frequency? What is the tenure? What are the conditions for reappointment or resignation, if any??? The average board position, even in a NFP, is 200+ hours a year, particularly if you are not from the sector, so don’t take a board position lightly. (Also, you are likely not being paid, although you will receive non-financial benefit from doing so, including satisfaction, networking, fun, and making a difference.)

13. Are there any pending or past litigation? Tax arrears? Wages? Infractions? Staff difficulties? Red flags? Problems or issues??? (I would even do a search of the NFP and its executives, and even fellow directors, as a precaution. Many of these searches can be done online, but if you have red flags, there are several professionals who can help you with this due diligence. I can recommend some.)

14. What are the quality and ethics of the Executive Director and the management team (including CFO, and internal audit if it exists)?? This question is very important.? Is there a code of conduct and it is effective and enforced? If it a large NFP, you may want to speak to the external auditor and even the internal audit function.

15. How is the Executive Director assessed?  By whom?  How is compensation for him/her and staff established?  Does the full board consent? Is compensation transparent, including to external stakeholders? (There have been past weaknesses on the issue of compensation, setting of it, approval and disclosure. Assume self-interest on the part of executives, and know what the role and power is of the board.)

16. Are there conflicts of interest between volunteers or operational roles and director/governance roles?

17. Does the organization have a whistle-blowing procedure? Is it effective? What are the ethical reporting procedures to, and oversight by, the board?

18. Does the board assess its own performance? ??Including the chair?

19. What are the professional development and learning opportunities on this board? What is the orientation program?

20. Lastly, why do you want to serve as a director of this NFP board? Does this board and sector align with your long-term career and director profile and trajectory? This may be your first board, and your first board likely is a NFP or governmental board, so plan for the future. If you are not entirely confident in the above and have any red flags, say “no thanks.” More directorships will come along and remember, your subsequent directorships are based on your first one, so be careful in joining the “right” board for you. Then your directorial career can flourish.

Even if you get answers to many or most of the above questions, you will be in good shape as an incoming director. Good firms and people should have no hesitation whatsoever in answering fully these questions. (I have seen all of them answered in my own experience.) They know that their own reputation and that of the NFP are involved and they want the best directors they can find. You also establish your diligence but do so in a nice and professional way.

Hope this all helps!

Should governance lawyers be independent?

Dec 20

Posted in Independence and Role Clarity, Shareholder Accountability | Comments Off on Should governance lawyers be independent? |

Most boards need professional advisors, such as auditors, compensation consultants and lawyers. After Enron and WorldCom frauds of 2002, regulators stepped in to ensure that auditors were hired by – and accountable to – the audit committee of the board, on behalf of shareholders, and not hired by or unduly influenced by the CFO as they once were. After the financial crisis of 2008, regulators stepped in (in 2012) to ensure that compensation consultants were hired by the compensation committee of the board and not hired by or unduly influenced by the CEO or other management. What about lawyers? Should lawyers who act for management also advise the board of directors? I don’t think so.

Now there are strict independence requirements for both auditors and compensation consultants. Their primary client is the board of directors and ultimately shareholders, whom the board is there to represent. It is entirely probable that if you do your job properly as an auditor or compensation consultant, that you will make recommendations that management will not like. You are there to act on behalf of the board and shareholders, not management. You cannot have dual masters and fulfill your fiduciary duties to only one as a professional. Indeed, auditors and compensation consultants cannot provide any additional services to management without the express consent from the board or a committee of the board. This authority is – or should be – rarely granted now.

Lawyers are equally important in the field of corporate governance. They interpret and apply legislation and offer advice to a variety of constituencies – shareholders, directors, managers and other stakeholders – who have interdependent and even adverse interests in the well being of the corporation and the competition for scarce resources. If the above reasoning is correct, so far as auditors and compensation consultants is concerned, strict independence should also apply to lawyers.

What this means is that a lawyer (or even a law firm) who has acted, or currently acts, or seeks to act, for management, should be prohibited from also acting for the board. This independence requirement is not practiced currently. There are numerous lawyers and law firms who act for both management and boards. Because most fees originate from management work, the consequences of this is a pro-management bias exhibited by lawyers who have drafted protection and entrenchment mechanisms for management such as poison pills, dual class shares, restrictions on meetings and voting, and staggered boards. Lawyers then resist pro-shareholder governance reform such as majority voting, say on pay and proxy access.

When interests between management and shareholders become adverse, even through the regular course of events, it is important for boards to have their own set of lawyers who are independent from management and seen as objective and willing to act in the interests of directors, not management, and ultimately shareholders. Management lawyers frequently exhibit an anti-shareholder bias, using words such as “attack,” “dissident,” and “proxy fight.” See here for example: Dealing With Activist Hedge Funds. Shareholders suffer when the board retains advisors who are beholden to management.

Some services this new set of “governance-only lawyers” could offer include:

  • Drafting board guidelines, committee charters and position descriptions for the board [if drafted by management lawyers, as they are now, these policies are often pro forma, management friendly, and restrict the board unnecessarily];
  • Board and committee reviews of effectiveness [typically these reviews are done by management or management lawyers currently];
  • Advising the board on activist shareholders, institutional shareholders and overall shareholder engagement [these governance lawyers would have a shareholder not a management mindset];
  • Reviewing and opining on the annual proxy circular, on behalf of the board [typically the board does not have the time to do a detailed review];
  • Review of the strategic planning process and value creation by management, on behalf of the board [again, with a shareholder mindset];
  • Negotiating and drafting the CEO contract and its terms, on behalf of the board and shareholders [typically a management lawyer drafts the agreement];
  • Assessments of risk management and oversight functions, on behalf of the board [again, the assessment would be independent of management and lawyers would work with independent auditors as necessary];
  • Ongoing coaching and development and review of implementation of policies, on behalf of the board.

All of the above activities and services are currently offered by management lawyers primarily from the point of view of management, not the board and not shareholders. This needs to change. The lawyers involved should fall into line (or camps), just like the auditors and compensation consultants have. There is room for governance lawyers who are unambiguously there to act only for directors, on behalf of shareholders.

What boards and individual directors can learn from Toronto Mayor Rob Ford and managing conflicts of interest

Nov 29

Posted in Ethical Leadership, Citizenship and Integrity | Comments Off on What boards and individual directors can learn from Toronto Mayor Rob Ford and managing conflicts of interest |

What is the lesson here for boards of directors and individual directors and officers? Avoid conflicts of interest at all times, but if and when they do occur, the test is perception and process. Every board should have a conflict of interest statement that applies to officers and directors, and to a control person or significant shareholder if applicable. It should cover identification and resolving of the conflict. If you are in doubt as to whether you have a conflict, you must disclose and cannot influence or take part in a decision, transaction, arrangement or otherwise in which you: can be perceived to have an interest, direct or indirect; cannot be seen to be impartial from an outsider point of view; or receive a benefit not shared by other shareholders. If you do take part in the decision, or do not disclose the potential conflict, or attempt to influence the vote, you risk detailed legal scrutiny after the fact to show your conduct was improper and did not conform to best practice. Records of the matter should be kept, a special committee may need to be formed composed only of directors who are seen to be independent in all ways from the matter and the director or officer or shareholder with the conflict, and expert independent advice should be sought. These best practices will protect the board as well as yourself and your reputation that you acted prudently, exercised your duty of care, were transparent, and acted only in the best interest of the company and all shareholders.

Mayor of Toronto Rob Ford’s Errors

Nov 28

Posted in Uncategorized | Comments Off on Mayor of Toronto Rob Ford’s Errors |

Rob Ford apologized yesterday, but that should have occurred months if not years ago when the letterhead to solicit donations was used. He said he did not benefit from the conflict of interest. This is not only incorrect, but also not relevant. Conflicts of interest are based on perception, not what the recipient thinks.

Ford made several strategic errors. Here they are:

  1. He did not take advice, legal or otherwise, the judgment confirms. This is remarkable. The Municipal Conflict of Interest Act is a “sledgehammer,” according to Professor David Mullan and former Integrity Commissioner. I agree. There should be graduated penalties commensurate with infractions, rather than declaring the seat vacant. A lawyer could have predicted that this conflict would end up putting a stranglehold on Ford and removing him from office. Ford was not even familiar with the above Act, he acknowledged under cross-examination. He was also alleged by the Integrity Commissioner to be in violation of the Code of Conduct at Articles IV, VI and VIII, and by requesting forgiveness of the donations, the Lobbyists’ Code of Conduct. Justice Hackland found Ford had a “dismissive and confrontational attitude” towards the Code.
  2. Ford did not act on the advice he did get. He was instructed, immediately preceding a vote, not to vote on a motion in which he had a pecuniary interest. Ford refused, and not only spoke to the motion, but also voted on it. This was a fatal flaw. It is entirely correct that Ford ought to have had the opportunity to speak as a matter of procedural fairness, as his lawyers argued in the judgment, but that was not what the Act read. (The Act really does need to change to enable a person alleged to be in conflict to speak to the issue in an open forum.)
  3. Ford stubbornly refused to acknowledge the case against him. And it was a silly, amateurish case that should have been avoided. Ford should have known better. Soliciting donations using government stationary implies the communication is official and carries credibility on which the requesting party is trading. It opens the door to expectations by lobbyists of favorable treatment resulting from the donation. This, precisely, is what the Act seeks to penalize. The recipients or cause – or even the quantum ($3,150.00) – is not the issue. Indeed the more deserving the cause, the greater the likelihood is that the conflict will be acute and unrecognized.

The Integrity Commissioner’s report, which Justice Hackman referred to as “excellent,” reads:

“In fairness to Councillor Ford, it is common for a person who has blurred their roles to have difficulty “seeing” the problem at the beginning. It often takes others to point out the problem, especially in a case where the goal (fundraising for football programs for youth) is laudable. The validity of the charitable cause is not the point. The more attractive the cause or charity, the greater the danger that other important questions will be overlooked, including who is being asked to donate, how are they being asked, who is doing the asking, and is it reasonable to conclude that a person being asked for money will take into account the position of the person asking for the donation.”

And it is not the case that Ford did not benefit.

The Integrity Commissioner goes on to write,

“Where there is an element of personal advantage (in this case, the publication of the Councillor’s good works, even beyond what they had actually achieved), it is important not to let the fact that it is “all for a good cause” justify using improper methods for financing that cause. People who are in positions of power and influence must make sure their private fundraising does not rely on the metaphorical “muscle” of perceived or actual influence in obtaining donations.”

This is the heart of the case against Ford. Justice Hackland wrote that Ford ignored the law, did not secure professional advice, and this amounted to “willful blindness.”

Regardless of one’s politics, this case was not well handled by Ford. His legal team is expected to apply for a stay of the judgment and file an appeal.

Governance at the Salvation Army

Nov 27

Posted in Not-for-Profit Board of Directors | Comments Off on Governance at the Salvation Army |

The Salvation Army recently dismissed Mr. David Rennie, its executive director of its toy warehouse in Toronto, where there was an alleged “massive” theft of $2M in children’s toys. This amount of toys, which were recently located, along with Mr. Rennie surrendering to police, cannot be carried out under one’s arm. It likely involved inadequate internal controls over the segregation of duties, over the safeguarding of assets, and over restricted areas. Perhaps paper rather than IT controls were being used (still not uncommon), which is more capable of manual override.

A qualified audit opinion was offered by the Salvation Army’s external auditors, KPMG, over the last three years (see here and here). According to Stanford researchers, the external audit process (see slide 10) should include fraud evaluation, a review of opportunities for fraud, and an examination of incentives for fraud. Auditors should use “professional skepticism,” but it is not the explicit objective of the audit to identify fraud (slide 9).

It is unclear, judging from the Salvation Army website, whether the Governing Council of the Salvation Army has adequate independence from management or financial expertise (see page 31 here), where independence or financial background is not mentioned). There is an advisory board, but there is no indication that the Salvation Army has a proper, functioning board of directors, that oversees risk and controls. Advisory committees advise, but cannot direct.

Theft happens when there is opportunity, incentives and lack of internal controls. A board, or lack thereof, controls and approves all of these factors – and in particular, controls. I was in Calgary after the XL Foods crisis, lecturing to a room full of directors on beef association boards in Alberta. “Do you approve the internal controls over food safety?” I asked? Not many hands went up. “Do you take tours of the plant, seeing the line, and talking to workers? Do you have an internal audit function that tests the design and effectiveness of internal controls, and reports directly to you?” Again, not many hands went up.

A proper board will want to see validation over the internal controls over all material risks – in the form of real time risk registers with individual accountability and mitigating actions. Material risks are not just financial, but non-financial. This includes operational controls, such as the line in a meat plant, or the warehouse with toys in it. I did a review of a diverse, complex NFP operation last week where documented risk management and operational control oversight by the board was inadequate. I am recommending 45 governance enhancements including a compliance committee of the board and proper risk oversight. I am designing a not for profit and governmental governance accountability course within York University’s Masters of Financial Accountability (MFAc) degree program this January given the importance of not for profit organizations to the economy, and the presence of governmental corruption.

Internal controls basically constrain management. No one likes to be controlled and there is an obvious aversion to management controlling itself or dedicating resources for this. In not-for-profits and charities especially, there are stretched resources, volunteers, and a tendency to trust people. However, fraudsters exploit these areas of vulnerabilities. Controls need to be person-proofed and require a diligent board with authority and competency to require adequate reporting, controls and follow up. Sadly, this was not the case at the Salvation Army and the board (or lack thereof) is at fault. Donations may suffer but more importantly, so may children at this time of year.

Regulators turning up anti-bribery heat on corporate boards: But will practices change?

Nov 19

Posted in Audit Committee, Ethical Leadership, Citizenship and Integrity, Global Corporate Governance, Risk Governance and Combined Assurance | Comments Off on Regulators turning up anti-bribery heat on corporate boards: But will practices change? |

Russia is one of the most corrupt nations in the world (see a recent anti-corruption story on Russia by the New York Times). It ranks 143rd of all 182 countries on Transparency International’s corruption perception index, with a score of 2.4. Canada ranks the 10th least corrupt country in the world with a score of 8.7. New Zealand is the least corrupt country globally, ranking first with an overall score of 9.5. The US ranks 24th and the UK 16th, with scores of 7.1 and 7.8 respectively. See the “Full Table and Rankings,” where countries can be searched via the table. Lower rankings and higher scores mean the country is perceived as being less corrupt.

Prime Minister Harper visited China, India and Brazil to enhance trade with these countries, which are also some of the most corrupt nations in the world, ranking in at 95th, 75th and 73rd respectively. Libya, which involved the alleged Montreal-based SNC Lavalin bribes of some $56 million, comes in at 168. Within these countries, the governments themselves are the net beneficiaries of much of the corruption, so these politicians are far from motivated to impose reform.

Is it realistic to expect that Anglo-American nations, such as the US, UK and Canada, can impose “Western” will on the very way business is done, and has been done, in some countries for centuries? And if things will not or perhaps cannot change, should home country boards of directors be held responsible for systemic local corruption that may be beyond their control?

Regulators are taking corruption and the role of boards and senior management very seriously. The Securities and Exchange Commission and Department of Justice recently released 130 pages of guidance (see the PDF and other coverage here and here) on the Foreign Corrupt Practices Act (“FCPA”). The US has had the FCPA since 1977. Enforcement and penalties have gone up dramatically in recent years. The UK Bribery Act, from 2010, has some of the most stringent bribery laws in the world. In Canada, we have The Corruption of Foreign Officials Act (since 1999) and the recent guideline from the OSC for issuers operating in emerging markets (see the PDF).

Emerging economies are future markets for Canadian companies. The Prime Minister has a vision for Canada to be an energy supplier superpower. For this to happen, Canada will shift its trade to markets with 100s of millions or billions of consumers and much higher growth rates than our current major trade partner, the US, which could be coping with austerity due to its debt for years to come. Harper was in India last week to boost trade.

What is clear is that there is an enormous disconnect between the home country regulations now being imposed, and host country actual practices on the ground.

What should boards that have operations in emerging market jurisdictions do? Six things. First, if you are doing business in such a market, you need a director with extensive on-the-ground experience at the board table, who can tell you and management what the hotspots are. You should move a board meeting to the jurisdiction once a year so directors can get a first hand look. Second, boards must make it crystal clear to management that if the company is not going to bribe, management must walk away from certain business. And the board must support this and not have incentives that promote bribery. Third, the internal controls over financial reporting must be as strong in the emerging market as it is in the home market. Investment and resource commitments need to be made. Fourth, boards must have their own experts to scrutinize off-balance sheet and related-party transactions and complex structures; validate and assure internal controls; and provide foreign language document translation. Fifth, local auditors should have the same oversight, scrutiny, and as necessary direct contact with the audit committee that the home auditors have. Lastly, there needs to be zero tolerance by the board communicated to each employee and supplier. The UK is even banning facilitating payments, which are regarded as a “tip,” as these may be bribes in disguise.

Companies and politicians are feeling the pain, including on Canadian shores. The Wal-Mart bribery probe has widened beyond Mexico to include China, Brazil and India. The RCMP is investigating the SNC Lavalin bribery allegations, on which I advised a law firm suing the company. I blogged about Sino-Forest, a case of alleged Chinese fraud by a Canadian-listed company. In Quebec, the corruption inquiry has cost the Mayors of Montreal and Laval their jobs and this is only the beginning. There are allegations of kickbacks in cash that may reach other more senior politicians. And Ontario is not immune either. A senior Canadian director remarked that Ontario has a reputation for being “the best place to carry out a stock fraud in the industrialized world.”

Clearly, more work needs to be done. Canada’s corruption ranking on Transparency International may go down in 2012 instead of up.

Banking Directors Need to be at the Top of Their Game

Nov 10

Posted in Financial Institution Governance, Risk Governance and Combined Assurance | Comments Off on Banking Directors Need to be at the Top of Their Game |

There’s an old maxim that corporations don’t fail, boards do. And when banks fail, the reason is poor management, which is the fault of a poor board.

Take the case of Lehman Brothers, the financial services firm that collapsed in 2008 and played a big role in the global economic downturn. Stanford University professors David F. Larcker and Brian Tayan noted that Lehman’s board was lacking financial services experience and current business acumen. In fact, the former CEOs on the board were, on average, 12 years into their retirement. “This raises the question of whether the professional experiences of Lehman board members were relevant for understanding the increasing complexity of financial markets,” wrote Larcker and Tayan.

Well, the job of a bank board isn’t getting any easier. Following the financial downturn, banks have been placed under greater scrutiny and new regulations, both in Canada and abroad.

That’s why, more than ever, banking board directors need to be at the top of their game.

Last week, I spoke to bank directors in Dallas, Texas, about banking governance best practices as a result of a review that I had conducted for the Office of the Superintendent of Financial Institutions. (The OFSI is Canada’s banking regulator.) Specifically, I looked at Canada’s governance guidelines and board assessment criteria and compared them with international financial regulatory practices and recent developments. I provided the OFSI with suggestions for revisions.

Some proposed board reforms to Canada’s deposit-taking institutions and insurance companies sectors under the new guidelines include:

  • Having directors who possess risk management and relevant industry experience;
  • A risk committee that oversees enterprise risks, and a chief risk officer who reports directly to this committee and the board;
  • Board approval of the internal control framework to mitigate all material risks to the financial institution, and board monitoring of internal control effectiveness;
  • Expert third party reviews of the board’s effectiveness, risk management effectiveness, and effectiveness of oversight functions (such as internal audit), with results reported to the board;
  • Enhanced director orientation and training, self assessment and external reviews;
  • A board-approved risk management statement that translates into cascading limits and thresholds for all material business risks (e.g., credit limits, loan losses, capital levels);
  • The internal audit function should report directly to the audit committee; and
  • The audit committee, not management, should approve the scope of the external auditor’s engagement and fees.

When I asked for a show of hands as to how many banking directors adopted at least some of the above best practices, about half the hands went up.

However, it’s apparent that many boards aren’t prepared for a new era of banking regulations.

Remember the JPMorgan board of directors that oversaw the derivative failure that cost the bank several billion dollars? Well, here is the current board. Last I checked, not a single director other than the CEO had banking experience. This is wrong.

In 2009 and 2010, there were a total of 297 bank failures in the U.S., according to the Federal Deposit and Insurance Corporation. In the second quarter of this year, the FDIC identified 732 “problem” banks which are at risk of failing.

At the event in Dallas, one of the speakers brought up a good point. “Don’t get involved in something you don’t understand,” said Charles G. Cooper, commissioner of the Texas Department of Banking. He added: “The duties haven’t changed, but the topic is harder.”

And he’s right. That’s why it’s vital that banking boards are well-equipped with qualified directors for this increasingly complex environment.

 

Trust and integrity in corporate governance

Oct 27

Posted in Ethical Leadership, Citizenship and Integrity, Uncategorized | Comments Off on Trust and integrity in corporate governance |

I served on a panel this week with the CEO of a financial institution, among other panelists. We were talking about compliance with emerging governance regulations. The audience was primarily lawyers. Towards the end of the discussion, the CEO made a brief remark about the importance of trust on a board. “Trust is not in any of the regulations,” he said. Quite true. We didn’t have time to elaborate during the panel, but I want to expand on this issue by defining trust and integrity and outlining three types of governance relationships requiring trust, with examples, below.

Trust is crucial in a board environment to promote transparency and accountability. Without trust, there are gaps in oversight and information flow. Decision-making failure can result.

Trust, however, is underpinned by personal integrity. Integrity is the building block of trust.

“Integrity” has a very specific meaning in the governance context. “Integrity” means consistency between what a director says, writes and does. It means authenticity, candor, reliability, confidentiality, solidarity, and a willingness to accept personal accountability and be bound by board decisions and a director’s own role within them.

Most importantly, “integrity” means putting the interests of the organization above your own, and even putting your own reputation or that of the organization at risk in doing so. It means having the courage to take significant principled action when necessary, for the ultimate good of the company. “Integrity” also means using power appropriately and always acting in a way that withstands the harshest scrutiny. Integrity is one of the highest bars in the governance game because the opportunities for self-interest and enrichment are so plentiful.

If a manager or director has defects in integrity, in any of the above examples, others will not trust them.

There are at least three major types of trust in the governance context: (i) Board-CEO, (ii) CEO-C-Suite, and (iii) Director-Director trust.

(i)       Board-CEO trust

First, the board needs to trust the CEO to bring full disclosure and transparency into the boardroom. The CEO will not disclose fully if one or more directors do not possess integrity or the CEO does not. A CEO needs to trust a board that directors will react to candid thoughts and pre-plans in a mature, measured and confidential way. A CEO’s integrity is equally important. If a CEO is defensive, holding cards close to the vest, and selectively disclosing, a board will know this and get frustrated. Crucially, if a CEO ever holds back key information, or misleads the board, there is only one chance. The Board-CEO relationship will be permanently impaired.

I remember one meeting I observed when the CEO sat with arms folded, with a laptop (a barrier as no other directors had a laptop), and was interrupting directors, in an almost antagonistic way. My debrief with the board chair was that there was agreement among directors that they are left with a sense they are not being told everything. I developed a coaching program with the CEO based on improved board-CEO relations, proper disclosure and information flow, and improved body language and technique for board meetings. I also recommended adjusting the CEO’s compensation to include, among other factors, improved board-CEO relations. This worked in the short term, but the CEO still was not trusted by the board and was replaced.

(ii)      CEO-C-Suite trust

Second, trust is important between the CEO and C-Suite. If the CEO is not trusted by the troops, they cannot lead. The board should know what the views are of the CEO by direct reports. In a board review I undertook recently, I canvassed the views of all direct reports to the CEO, otherwise known as a “360 review.” I recommended to the independent Chair that all directors see these views. The C-Suite also had opportunity to express views on the directors and where they could improve, which was very helpful (and eye-opening) to directors. The directors had opportunity to express views on the CEO. What ultimately occurred was dissatisfaction by the C-Suite in the CEO and specifically a lack of trust. The CEO was replaced by the board soon after.

(iii)     Director-Director trust

Third, trust is also important between and among directors. Directors need to trust each other that each director will support board decisions once they occur, will respect confidentiality, will be consistent and honest in what they say and do, and will act only in the best interests of the company. If a director or chair acts out of self-interest, directors will not work as a coherent team. Issues will be avoided because of undue influence, entrenchment and self-gain.

I conducted a peer review recently (directors assessing each other) and it was apparent that one director had integrity concerns by many others. I convened a meeting with the board chair and governance committee chair. Without breaching confidence, I advised of this gap and ultimately the director who had the low integrity rankings was asked to resign.

So building an effective board takes a key step: “Integrity” is an important attribute in directors and officers and contributes to trustworthiness and “doing the right thing” in the interests of the company.

Integrity is so important that it should be recruited for, developed, and assessed. Don’t avoid assessing and having internal controls over integrity. It can be done. And if a director or manager doesn’t possess integrity, they need to go. In the words of Warren Buffet:

In looking for someone to hire, you look for three qualities: integrity, intelligence, and energy. But the most important is integrity, because if they don’t have that, the other two qualities, intelligence and energy, are going to kill you.

Recruit directors and officers with the utmost integrity and replace those who do not have it. Your board will be better for it.

New financial services governance guidelines for Canada: Analysis & summary

Oct 12

Posted in Global Corporate Governance, Governance of Financial Institutions, Risk Governance and Combined Assurance | Comments Off on New financial services governance guidelines for Canada: Analysis & summary |

The proposed OSFI corporate governance guidelines have been criticized for blurring the line between the board and management and for adopting a ‘one sized fits all’ approach. This is hardly surprising, and is the criticism to many governance regulations over the last twenty years, along with cost, as boards have become more active.

The OSFI guidelines have not changed in almost 10 years. In full disclosure, I was asked by OSFI to a) conduct a review and assessment of OSFI’s 2003 Corporate Governance Guideline and the Board Assessment Criteria against other international financial regulatory practices and recent developments or recommendations, and b) provide suggestions for future revisions after taking into consideration current global governance developments, including those related to financial institutions.

I reviewed 57 codes in total for OSFI, carefully tracking developments globally since the financial crisis. There are four major changes (among others) since the 2003 guidelines as follows:

1.         Boards of federally-regulated financial institutions (FRFIs) will need to have risk and relevant financial industry expertise represented in their board. This is entirely reasonable and codifies what good boards already do in their competency matrix approach that I recommended to the OSC in 2005. The notion that a board such as JPMorgan should have no independent directors with banking experience, for example, can have dire consequences when approving complex products and risks that directors do not understand for want of expertise. OSFI is not being overly prescriptive, only saying it desires “reasonable representation” of risk and financial industry expertise, leaving it to FRFIs to define and determine. It is not unreasonable to have risk and industry expertise on the board of a financial institution.

2.         Second, independent third parties should be retained to assess the board, risk management and oversight functions. This does not mean the board is “managing,” but rather the board gets to see an objective view other than from management. Management is conflicted in assuring its own work and the board should not be beholden to this. The board should be free at any time to commission an independent review of any material risks or internal controls. This puts the heat on management, as a third party will be reviewing at some point. If management is doing its job, it should welcome this input. This proposal can be criticized for “offloading” oversight to outsiders, but with 100s of FRFIs that carry deposits and insurance of Canadians, independent reviews from time to time are a fail safe.

3.         Third, the board may need to have a dedicated risk committee and reporting function (e.g., CRO); and should approve a risk appetite framework (RAF) with cascading tolerance limits and implementation. This puts the heat on boards to know and understand the risks of their institution, and on management to translate that into thresholds complied with throughout the organization. OSFI set out at pages 19-20 of the draft guideline guidance on what the RAF should contain with areas and examples of best practices. It is not unreasonable for the board to approve risk, but with examples of what this actually entails. The OSC 2005 guideline (NP 58-201) is now out of date because risk is only a few lines: namely that the board should identify the principal risks and ensure implementation of appropriate systems to manage these risks – which is vague at best and wholly inadequate at worst.

4.         Lastly, the CFO, head of internal audit and appointed actuary (for insurance companies) should have a direct reporting line to the audit committee; and the audit committee should approve the external audit fees and scope. Not only is this best practice, internationally, but I would also add, as OSFI similarly goes on to write, that the audit committee should have private sessions with the internal audit, external audit and appointed actuary at every audit committee meeting. The audit committee should also approve the internal audit work plan, budget, independence, person and compensation.

Overall the draft OSFI guidelines are proportionate, pragmatic and reflect leading practices (e.g., G30, Walker and OECD reports and Basel principles). Canada has a very well regulated financial services sector, that some say is the envy of the world. These new corporate governance guidelines will help ensure that this fiscal prudence and stewardship continues.

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