Ethical Boardroom Winter 2017

Published by Ethical Board Group Limited | www.ethicalboardroom.com

Winter 2017

Keeping it above board

The cyber generals Internal audit can help boards detect risk

Deploying reputational risk Turning risk into an opportunity for good, sustainable business

Red Eléctrica

Chairman José Folgado on ethics, integrity and good governance

Adapting to the new reality and staying ahead of the curve

Sugarcoating extortion

Establishing policies to combat bribery and corruption

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How European companies can successfully manage their investor engagement process

Boards in the post-Brexit era

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Keeping on the front foot

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Ethical Boardroom | Contents

COMMENTARY

18

10

A roadmap for long-term value creation in the capital markets Integrated reporting is taking companies in a new direction

12

Incentive compensation and corporate recklessness Companies should adopt clawbacks that apply more broadly than statutory provisions

14

What a board doesn’t know can hurt it Ignorance is no excuse for bad governance. Boards need trained, independent and proactive directors

16

Business can earn a licence to lead How do you go from a resource taker to a market builder and still generate value?

18

Rise of investor interest in ESG Environmental and social factors are being widely used as indicators of whether a board is up to its job

78

24

20

The Trump effect What the world can expect following the historic 2016 US presidential election

22 24

Global News Europe Diversity, transparency, bribery, oversight and shareholders COVER STORY: Red Eléctrica: Switched on to good governance The Spanish electricity system operator is committed to good governance

ACTIVISM & ENGAGEMENT

28

Engaging with passive investors Index fund holdings have found their voice... make sure you don’t ignore it

30

Proxy fights: Don’t underestimate the risk Five crucial mistakes companies make in an era of shareholder activism

C

O

V

E

R

S

T

O

R

Y

34

Turning the wheels of investment Changing tactics will establish companies that deliver long-term, sustainable value for customers, employees and shareholders

38

Keeping on the front foot How European companies can successfully manage their investor engagement process

4 Ethical Boardroom | Winter 2017

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Contents | Ethical Boardroom

42

42

Shareholder engagement: An evolving landscape The best defence is a strong offence – preparing for and engaging constructively with activists

ASIA & AUSTRALASIA

46 48

Global News Asia & Australasia Transparency, gender diversity, corruption and governance standards Corporate governance in Japan now Charting progress made in the 18 months since the introduction of the Japanese corporate governance code

TECHNOLOGY

52

Information governance oversight: Questions for board members to ask Good IG isn’t just about protecting an organisation from data breach

56

How the general counsel can shape information governance Ensuring proactive information governance can help companies prepare for data challenges

THE AMERICAS

60 62

Global News The Americas Sustainability, bribery, corruption and CEO pay

20

CONTENTS 74 58

Disclosure in Latin America Not all companies in the region are ready to reveal all

BOARD GOVERNANCE

66

Board members as cyber generals Internal audit leaders need their risk-detection antennae up high

70

The board’s role in talent and culture Visionary boards go beyond simply setting compensation policies

74 78

CEO pay ratio: Stay prepared Why companies must continue with CEO pay ratio implementation plans Remuneration practices within Southern Europe Shareholder concerns and expectations have changed management incentives in recent years – but will this impact on transparency?

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Winter 2017 | Ethical Boardroom 5

Ethical Boardroom | Contents

82

Do you have a life plan?

Taking responsibility for your personal governance is a conscious, strategic and operative form of permanent personal development

82

BOARD LEADERSHIP

88

Reaching for the reset button Behavioural shortcomings and operational weaknesses are at the root most company failures

92

10 high-performance board barometers Proactively shaping a culture, based on the best of all possible cultural norms, should be the aspiration of any boardroom

96

Board composition in the post-Brexit era Diversity of perspective and experience, as well as vision and imagination, are critical board qualities

112

136

100

Questioning quotas Setting targets to create gender -balanced boards has been shown to work in many countries and yet it still often offends our notion of meritocracy

AFRICA

104 106

Global News Africa Bribery, diversity, kickbacks and boardroom shuffles Improving business behaviour in Africa Establishing coherent guidelines for corporate governance is becoming a priority in the continent

108

Ensuring corporate integrity Four practical ways for African companies to boost their ethical profile

96

THE EB 2017 CORPORATE GOVERNANCE AWARDS

110

Introduction & Winners list We reveal our 2017 European and African Award winners

112

The Vodacom way A company where good corporate, social responsibility and ethics are central to our sustainability

114

Aspen aspires to excellence in corporate governance Africa’s largest pharmaceutical company is committed to ongoing improvement of corporate practices

6 Ethical Boardroom | Winter 2017

92

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Contents | Ethical Boardroom

REGULATORY & COMPLIANCE

116

Anti-bribery compliance in a changing world Global indicators and how the TRACE Matrix can help you assess the health of particular regions and markets

120

Sugarcoating extortion Establishing policies to combat bribery and corruption is pointless unless you tackle the problem of corrupt local officials

124

100

FCPA enforcement: The individual criminal prosecution gap The Yates Memo has shifted the focus of criminal investigations from corporations to individual wrongdoers

128

Delivering an anti-corruption framework that works Nailing the right strategy will help protect your reputation

130

What makes a first-class training programme?

Following the right compliance training programme will arm you with the knowledge for becoming the best compliance professional

132

114

Whistleblower: A hero, a villain or simply a fool?

A code of ethics means nothing if employees who have the courage to expose corruption are not protected

MIDDLE EAST

144

134

Global News Middle East Institutionalisation, compliance and governance standards

RISK MANAGEMENT

136

Deploying reputational risk 2.0 Setting up a framework for turning risk into an opportunity for good, sustainable business

140

Getting to grips with New York’s cybersecurity compliance rules Proposed regulations require organisations to have extensive cybersecurity protections in place

144

Forecasting and responding to geopolitical risk in 2017 Brexit, the US election and more – the year ahead will be one of the toughest for directors

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Winter 2017 | Ethical Boardroom 7

Ethical Boardroom | Foreword

Welcome to the Winter 2017 edition of Ethical Boardroom magazine

Ethics and conflicts in the Trump era Much has been said and written about Donald Trump’s extensive, international business holdings and how he will need to make decisions as leader of the US that also affect the Trump empire.

Ahead of his presidential inauguration, Trump called a press conference to reveal the ways he would separate himself from his global business but did little to calm the fears of many ethics experts.

Trump explained that he would hand over operational control of the Trump Organization – an umbrella company for his hundreds of investments in real estate, brands and more – to his two eldest sons (who will make all decisions for the company “without any involvement whatsoever” from Trump), abstain from new deals with foreign partners, refrain from discussing company matters and appoint an independent ethics adviser who will scrutinise new investment opportunities to prevent conflicts of interest.

If Trump thought these measures would satisfy ethical and constitutional concerns, it looks

8 Ethical Boardroom | Winter 2017

like he will need to think again. For many, his plans fall way short.

Trump’s decision not to sell his businesses was criticised by the director of the Office of Government Ethics, Walter Shaub, who said the plan didn’t “meet the standards… that every president of the past four decades has met”. Describing Mr Trump’s plan as “wholly inadequate”, he added: “Nothing short of divestiture will resolve these conflicts.”

Alicia Plerhoples, an associate professor of law at Georgetown University, wrote in the Washington Post, that “with Trump’s conflicts, corporate America wouldn’t hire him as CEO” and that by appointing his own ethics adviser to handle conflicts, rather than deferring to the Office of Government Ethics, Trump is “effectively telling his board and shareholders that a problem exists but that he is keeping them in the dark on the specifics”.

The one thing that is clear in this era of uncertainty, is that Donald Trump is now the president of the United States.

In this issue of Ethical Boardroom, we hear from contributors Michael Moran and Jonathan Wood as they explore how the new administration is likely to approach and influence global and regional politics worldwide, and how foreign governments are responding to the election result.

Nora McCord discusses the potential impact the Trump administration may have on CEO pay (page 74) and how companies should prepare themselves, while Charles Hecker and Jonathan Wood address geopolitical risk in the year ahead.

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Contributors List | Ethical Boardroom

Our thanks to this issue’s contributing writers JASON R. BARON Of Counsel at Drinker, Biddle & Reath LLP and Co-chair of the Information Governance Initiative

MICHELLE EDKINS Managing Director, Global Head of Investment Stewardship, BlackRock

NICHOLAS BENES Representative Director, The Board Director Training Institute of Japan

DOUGLAS LINARES FLINTO Chairman & CEO at Brazilian Business Ethics Institute

FABIO BIANCONI Director, Morrow Sodali

JOSÉ FOLGADO Chairman, Red Eléctrica

DR ANDREA BONIME-BLANC Chief Executive Officer and Founder of GEC Risk Advisory

JAKE FRAZIER & SONIA CHENG Jake is Senior Managing Director, Sonia Cheng is Senior Director, FTI Consulting

JONATHAN BOWDLER Head of Regulatory Compliance, International Compliance Training

BRUCE H. GOLDFARB Founder, President and Chief Executive Officer of Okapi Partners

DEBRA BROWN President and Chief Executive Officer of Brown Governance Inc

PAOLA GUTIERREZ VELANDÍA Principal, Regional Head of Board Services Iberia & Latam, Pedersen & Partners

JEAN-NICOLAS CAPRASSE & JULIA WITTENBURG Jean-Nicolas, Managing Partner, and Julia, Principal, CamberView Partners Europe

FREDY HAUSAMMANN Managing Partner, Amrop Switzerland and Vice Chair, Amrop EMEA

KRISTEN SAVELLE Associate Director of Empirical Research for the Rock Center for Corporate Governance at Stanford Law School

CHARLES HECKER & JONATHAN WOOD Charles is a Senior Partner, Jonathan is the Director of Global Risk Analysis, Control Risks

PROFESSOR RUTH SEALY Associate Professor in Organisation Studies at Exeter University Business School

RICHARD HOWITT CEO, International Integrated Reporting Council

SHAWN E. TUMA Cybersecurity & Data Privacy Partner, Scheef & Stone

TOM JOHNSON Chief Executive Officer, Abernathy MacGregor

RIAAN VERSTER Company Secretary & Group Governance Officer, Aspen

RICHARD F. CHAMBERS President and CEO of The Institute of Internal Auditors ROBERT CLARK Manager of Legal Research, TRACE International PROFESSOR JOHN COFFEE The Adolf A. Berle Professor of Law at Columbia University Law School and Director of its Center on Corporate Governance PETER CROW Accredited company director (CMInstD) and board advisor MONICA DOWIE Programme Manager of the African Corporate Governance Network at the NEPAD Business Foundation

GILLIAN KARRAN-CUMBERLEGE & LUKE MAIN Gillian is a Partner and Luke is a Research Associate, Fidelio Partners GEORG KELL Vice Chairman of Arabesque Partners MIKE KENEALY & MICHELE LA NEVE Mike is the Chief Operations Officer at Insiders Corp and Michele is a Managing Partner at Whitecotton Law International

JANNICE L. KOORS Managing Director, Pearl Meyer KAI HAAKON E. LIEKEFETT Head of the Shareholder Activism Response Team, Vinson & Elkins L.L.P MICHAEL MORAN & JONATHAN WOOD Michael is the Principal and Chief US/Macro Analyst; Jonathan is the Director of Global Risk Analysis, Control Risks TSHEPO RAMODIBE Executive Head of Department: Corporate Affairs, Vodacom Group REINER SACHS CEO, Shareholder Value Management AG JEREMY SANDBROOK Chief Executive, Integritas360

MICHAEL VOLKOV CEO and owner of The Volkov Law Group JULIA WITTENBURG Jean-Nicolas is Managing Partner, and Julia is Principal, CamberView Partners Europe ROMAN ZYLA Regional Lead, Africa Corporate Governance Program, in the Transactional Risk Solutions Department, Environment, Social and Governance, IFC

EDITOR Claire Woffenden DEPUTY EDITOR Spencer Cameron EXECUTIVE EDITOR Miles Hamilton-Scott ART DIRECTOR Chris Swales CHIEF SUB Sue Scott ONLINE EDITORS Allegra Cartwright, Hermione Bell PRODUCTION MANAGER Jeremy Daniels SUBSCRIPTIONS MANAGER Lucinda Green HEAD OF ONLINE DEVELOPMENT Solomon Vaughan ONLINE DEVELOPMENT Georgina King, Rosemary Anderson MARKETING MANAGER Vivian Sinclair CIRCULATION MANAGER Benjamin Murray HEAD OF SALES Guy Miller SALES EXECUTIVE Michael Brown PRODUCTION EDITORS Tobias Blake, Dominic White VIDEO EDITOR Frederick Carver VIDEO PRODUCTION Tom Barkley BUSINESS DEVELOPMENT Dammian Botello, Giles Abbott, Gerald Fox, Steven Buckley ASSOCIATE PRODUCER Suzy Taylor ADMINISTRATIVE ASSISTANT Abigail Fitzwilliam HEAD OF ACCOUNTS Penelope Shaw PUBLISHER Loreto Carcamo Ethical Board Group Ltd | Ethical Boardroom Magazine | 1st Floor, 34 South Molton Street, Mayfair | London W1K 5RG S/B: +44 (0)207 183 6735 | ISSN 2058-6116 | www.ethicalboardroom.com | Ethical Boardroom | twitter.com/ethicalboard Designed by Yorkshire Creative Media | www.yorkshirecreativemedia.co.uk. Printed in the UK by Webmart Ltd. Images by www.thinkstockphotos.co.uk All information contained in this publication has been obtained from sources the proprietors believe to be correct, however no legal liability can be accepted for any errors. No part of this publication can be reproduced without prior consent from the publisher.

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Winter 2017 | Ethical Boardroom 9

Commentary | Integrated Reporting

Richard Howitt

CEO, International Integrated Reporting Council

A roadmap for long-term value creation in the capital markets Integrated reporting is taking companies in a new direction – away from the ‘tragedy of horizons’

Let me suggest a new take on the debate about shifting to long-termism - something investors are often portrayed as having little interest in.

It is true that there is a natural tendency to review outcomes frequently and base investment decisions on recent history and events. It is only natural that emotions affect the way we think and act and it is hard to get emotional about the future – about things that we are not yet fully feeling the impact of yet.

Some, of course, are deliberately shortsighted. As the head of global structured products at the Royal Bank of Scotland said in February 2004: “We are investment bankers. We don’t care what happens in five years.” The date of this quotation stands out when you consider that the Royal Bank of Scotland was bailed out by the UK taxpayer precisely four years and eight months later.

10 Ethical Boardroom | Winter 2017

It is only natural, therefore, that these mindsets have been challenged over recent years. There is a growing school of thought that, for the success of our capital market system, it has to change. The likes of Mark Carney, governor of the Bank of England and chairman of the Financial Stability Board, are focussing global attention on what Carney calls the ‘tragedy of horizons’, which is defined as market failure that arises from not taking into account today known future risks – in this case, he was talking about climate change. This analysis strikes a chord with integrated reporting, which Carney has identified as a tool for communicating future risks and opportunity.

Future accountancy

The Financial Stability Board’s Task Force on Climate-related Financial Disclosures is a crucial signal that senior market leaders are increasingly recognising the importance of accounting for the future and I have pledged the International Integrated Reporting Council (IIRC) support for its recommendations and the action this garners in capital markets around the world.

Other partners that are doing important work in this space include Focusing Capital on the Long Term and the Coalition for Inclusive Capitalism. Both organisations are introducing evidence, ideas and innovative www.ethicalboardroom.com

Integrated Reporting | Commentary model, and the resources and relationships that they rely on to create value over time.

Integrated reporting has been created to provide investors with the information they need to make more effective capital allocation decisions and facilitate better long-term investment returns.

It is a two-way street, however, so moves by investors within the growing networks associated with the IIRC to make investment decisions for the long term must be backed up by accurate, dependable information from businesses. This challenge lies with the board and through good corporate governance.

Since the financial crisis, the need for boards to build trust in their businesses and demonstrate their contribution towards long-term economic stability has become a high priority. Integrated reporting is an indispensable part of achieving this.

Integrated reporting itself is an evolution of corporate reporting, with a focus on conciseness, strategic relevance and future orientation. As well as improving the quality of information contained in the final report, integrated reporting makes the reporting process itself more productive, resulting in tangible benefits.

Integrated reporting requires and brings about integrated thinking, enabling a better understanding of the factors that materially affect an organisation’s ability to create value over time. It can lead to behavioural changes and improvement in performance throughout an organisation.

THE MISSING PIECE Integrated reporting helps corporate decision making

steps forward to ensure we refocus our capital market systems on the long term.

While these and many more movements are flourishing, they are not yet embedded and that is the challenge for the next five years.

As CEO of the IIRC, I have the honour of leading the global coalition of individuals and organisations that seek to integrate this quest for long-term value creation, not simply into corporate reporting, but also into reform of capital markets.

Any investor worth their salt knows that past performance is no guarantee of future success. Increasingly that means that investors are looking beyond naturally backward looking financial statements to information about strategy, the business www.ethicalboardroom.com

an essential and inseparable part of corporate governance – it is the outcome of a corporate governance process – grounded in the purpose, values and activities of the business and reflecting on behaviour throughout the business, from the board and management team downwards.

General Electric in the United States, Generali in Italy, Itaú Unibanco of Brazil, and New Zealand Post, are just some of the 1,000-plus companies worldwide who have chosen to apply the <IR> framework.

An increasing body of evidence from the five-year take-up of integrated reporting demonstrates that an integrated and inclusive corporate governance system delivers practical benefits to both businesses and investors, including improved share price performance.

The corporate governance reforms announced by the UK Prime Minister, Theresa May, are an important opportunity to bring similar benefits to the UK markets.

Inclusive and integrated governance, where silos are diminished and management prioritises communication with stakeholders, attracts long-term investors, improves risk management and cuts the cost of capital.

Long-term perspective

The change in thinking and behaviour away from unrelenting short-term factors towards the longer term horizon is key to the work of the IIRC. As Lars Sørensen, CEO of the pharmaceutical Enhanced dialogue giant Novo Nordisk, which has adopted Integrated reporting is now the reporting integrated reporting, said: “The business framework of choice for major businesses in of business is business – but with a Japan. The Japanese government signposted long-term perspective.” to companies to adopt integrated reporting Integrated reporting is today practised as part of its corporate governance reforms by businesses in more than 30 economies, and as a means of a testament to the enhancing the dialogue universal applicability Integrated between companies of the concept and its reporting requires usefulness for embedding and investors.

Japan’s business leaders an integrated approach. and brings about increasingly appreciate How our capital markets integrated thinking, system the contribution that creates and integrated reporting can distributes wealth and enabling a better make towards achieving resources is a critical understanding of greater financial stability question that must be the factors that and a focus on long-term addressed with urgency. investment. This perhaps Our contribution is the materially affect comes more naturally to International <IR> an organisation’s the Japanese – of the 4,000 Framework. Integrated businesses globally that reporting is fundamental ability to create can boast a history of 200 to the governance of value over time years or more, more than institutions and economies half of them are Japanese. in the 21st century and The same focus on the future can be said I am committed to working tirelessly to of South Africa, where we welcomed the ensure more and more businesses across publication of its new corporate governance the world benefit through its adoption. code, King IV, in November 2016. It is the I encourage you to start the journey first outcomes-based governance code in towards integrated reporting in your the world and modelled on the International business and look forward to engaging <IR> Framework. Corporate reporting is with you.

Winter 2017 | Ethical Boardroom 11

Commentary | Incentive Compensation

Professor John Coffee

is the Adolf A. Berle Professor of Law at Columbia University Law School and Director of its Center on Corporate Governance

The story behind the scandal: Incentive compensation and corporate recklessness This year has seen a perplexing series of corporate debacles about which one can only ask: How did they think they could get away with that? Did Volkswagen really believe that its ‘defeat device’ would go undetected indefinitely? Did Wells Fargo think that it could fire 5,300 employees for the same fraudulent practice without someone noticing?

Did major pharmaceutical companies – most notably, Valeant Pharmaceuticals International and Mylan NV – really expect they could buy an established drug and spike its price 600 per cent or 700 per cent without protests occurring and Congress investigating?

Although no one link connects all these cases, many share a common denominator: the use of extreme incentive compensation.

Simply put, extreme compensation formulas can motivate reckless corporate behaviour.

To illustrate, let’s consider three examples.

First, Valeant Pharmaceuticals has been everyone’s favourite whipping boy over the last year and it remains the subject of a serious grand jury criminal investigation in the 12 Ethical Boardroom | Winter 2017

Companies should adopt clawbacks that apply more broadly than statutory provisions United States. Its business model was to acquire a drug (or a drug company) and then spike its price by 25 times or more.

For example, it acquired Cuprimine and moved its price over two years from $888 for 100 250 mg capsules to $26,189.

Standing alone, such behaviour is not unlawful. But Valeant did more. It used a captive online retail pharmacy, Philidor Services, to place orders for its drugs at these inflated prices, in order that insurers think that an independent decision had been made to choose the costlier drug, rather than a cheaper generic substitute. Until late in 2015, Valeant hid the fact that it controlled Philidor and was consolidating Philidor’s results with its own on its financial statements.

Whether or not this behaviour was criminal continues to be investigated by a grand jury in the US, but, without doubt, this behaviour was certain to elicit public outrage and regulatory attention. So why take this risk? Now, we get to the heart of the matter. Valeant’s CEO (until

he was replaced this year), J. Michael Pearson, had received a compensation package that paid him only $1million in cash annually, but also offered him an assortment of incentive compensation awards (basically stocks and options) valued at $16million. In particular, Pearson stood to receive performance stock units that would vest if Valeant achieved certain three-year compounded total shareholder returns (see table below).

In short, returns of under 15 per cent netted him nothing, but returns of more than 45 per cent paid him an extraordinary equity award of more than one million shares. Incentivised to take risk, Pearson responded with alacrity.

Now, let’s look at a second example: Mylan NV, is a major generic drug company. But, even after Valeant imploded and its stock price fell by over two thirds in the last year, Mylan opted to follow a similar strategy.

It raised the price of its key product, EpiPen, an emergency treatment for people with life-threatening allergies, from $100 to $600, thereby making the drug prohibitively expensive for persons without insurance. The public reaction was easily foreseeable and outrage and Congressional hearings followed.

Why did Mylan take this risk in the wake of Valeant’s experience? Here, one only has again to connect the dots. In 2014, the Mylan board approved a one-time stock award that was

SHAREHOLDER (1) Three-year Total Shareholder Returns “TSR” < 15% (2) Three-year TSR from 15% to 29% (3) Three-year TSR from 30% to 44% (4) Three-year TSR > 45%

AWARD 0 407,498 shares vest 814,996 shares vest 1,272,494 shares vest www.ethicalboardroom.com

Incentive Compensation | Commentary

GAME OF RISK Executives are playing dangerously to earn incentive compensation

conditional on Mylan more than doubling the company’s adjusted per share earnings over a five-year period, ending in 2018.

Because Mylan was in the mature and low-growth generic drug business, this had seemed an unattainable goal. Still, the company’s top five executives stood to gain an estimated $82million collectively if this target could be achieved. So incentivised, they spiked the price of EpiPen, its leading product, and attempted to ride out the storm. But, in October, Mylan settled alleged regulatory violations with the US Department of Justice relating to EpiPen for $465million, and the dispute still continues.

A final example this year of incentive compensation producing ethically dubious risk-taking and fraudulent behaviour is supplied by Wells Fargo & Co, until recently the US’s largest bank. At least 5,300 of its staff had their employment terminated over a five-year period for opening an estimated two million bogus accounts or credit cards for customers, without the customers’ knowledge or consent. Employees did so apparently to satisfy ambitious, but arguably unrealistic, sales quotas imposed by senior management.

Under pressure, lower echelon employees opted to cheat to avoid termination. But why did senior management persist in insisting on high cross-selling quotas once it became evident that the resulting pressure had produced systemic fraud? Again, the answer appears to lie in the incentive compensation senior executives could earn.

Carrie Tolstedt, the executive vice president who supervised Well Fargo’s ‘community www.ethicalboardroom.com

banking’ operations, made up to $1.7million in annual salary, but up to an additional $9million in some years in incentive compensation. Given this disparity, her motivation in imposing high cross-selling quotes on lower-level employees becomes understandable. Although such a formula paid her extraordinary compensation, it ultimately subjected her company to a reputation-shattering scandal.

Modernised clawback provisions may soon become the next focus of shareholder activism. Clearly, incentive compensation is here to stay, but it should be reasonable, not extreme, and counterbalanced by broad clawbacks Incentive compensation is, however, the norm today. The days when senior management was paid primarily in cash are long gone. Equilar, a leading compensation specialist, reports that in 2015, CEOs of companies in the S&P 500 received on average 60 per cent of their total compensation in equity. If enough incentive is created, it produces risk-preferring behaviour.

So what should a reasonable and prudent board or compensation committee do?

Obviously, one answer is to avoid the kind of extreme equity award that Valeant used to motivate its former CEO. Interestingly, that formula was actually designed by a risk-loving

hedge fund that had a seat on Valeant’s board.

But another answer is to counter-balance the impact of incentive compensation with an appropriately designed ‘clawback’.

Clawbacks mandate the forfeiture of incentive compensation (including unexercised stock options and equity awards) on the occurrence of specified events. They are only required under US law in the event of a subsequent accounting restatement that reduces the earnings that produced the incentive award.

Still, a responsible board can design a broader clawback that does not require a restatement to trigger it. For example, Wells Fargo has just clawed back a record $60million in unexercised stock options and performance stock awards from its now-retired CEO and Ms. Tolstedt.

Wells Fargo’s clawback provisions are in fact a model for other companies to emulate, as they authorise the board to clawback unexercised options and awards for conduct that foreseeably exposed the bank to reputational damage or that involved negligent supervision. This is far broader than the Dodd-Frank Act requires. Interestingly, this clawback policy was adopted in 2013 in response to pressure from New York City pension funds, who were seeking to impose an even tougher policy through a shareholder proxy resolution.

Modernised clawback provisions may soon become the next focus of shareholder activism. Clearly, incentive compensation is here to stay, but it should be reasonable, not extreme, and counterbalanced by broad clawbacks. Shareholders unite! You have nothing to lose, but your equity.

Winter 2017 | Ethical Boardroom 13

Commentary | Ethics & Compliance

What a board doesn’t VimpelCom’s $397.6million FCPA settlement revealed the serious consequences that can occur when a board of directors fails to adhere to ethics and compliance programme requirements. The VimpelCom board of directors failed to lead the company responsibly.

In the context of ethics and compliance, a failure to lead puts companies on the fast track to legal violations that can quickly result in a serious government enforcement action, reputational damage, collateral litigation and a threat to the company’s leadership.

We all know that a board is critical to establishing a company’s tone-at-the-top.

Creating the right corporate culture is much more than video statements and puffery about ethics and compliance. It is more than checking the box on the elements of a compliance programme. And, most importantly, it is more than making sure that the board can ‘defend’ its actions.

Looking back on the VimpelCom FCPA enforcement action, the board of directors failed to answer a simple question – who is

Ignorance is no excuse for bad governance.

Boards need trained, independent and proactive directors

the beneficial owner of two companies that VimpelCom proposed to acquire?

Unfortunately, the board never got an answer to that simple question and therefore suffered a serious consequence when it turned out the owner was the notorious daughter of the Uzbekistan president, a known corrupt official.

VimpelCom’s case is a learning moment.

The board needed to investigate this matter further, demand that its staff provide information confirming the ownership of the target companies, given the corruption risks, and then make the proper decision.

A proactive board would have rejected the transaction and avoided a very costly mess.

A new dynamic is needed in the corporate boardroom. When individual directors embrace a new mindset of proactive governance, premised on doing the right thing rather than finding a way to excuse doing the wrong thing, corporate culture, profitability and sustainability will succeed.

well-established self-assessment models.

Corporate boards are often composed of talented, experienced and smart people, but functioning as a successful board requires more than those individual skills.

Boards need to develop their own expertise in order to successfully lead a company.

Corporate boards have to be held accountable for their performance and commitment to compliance.

One key principle underlying improved board performance and responsibility is independence. Corporate boards are no longer under the domination or control of powerful CEOs; instead, corporate boards are developing into independent and resourceful leaders.

The days of a CEO serving as the chairman/ chairwoman of the board are less frequent. In the 1990s, approximately 80 per cent of public companies had a single person serving as chairman/chairwoman and now the number is down to around 40 per cent. The percentage of independent directors has been rising and now exceeds 80 per cent of all board seats.

How to hold your board accountable

While companies are expanding internal compliance programmes, companies fail to take a hard look at their own corporate board performance beyond rote and

14 Ethical Boardroom | Winter 2017

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Ethics & Compliance | Commentary

know can hurt it Governance and training

There is a dirty little secret out in the corporate governance world, so listen closely: sometimes board members and C-Suite executives do not understand what the law requires and how a compliance programme is supposed to work. Corporate boards and senior executives are responsible for oversight of a company’s compliance programme. If they lack basic education and understanding of the legal risks, they cannot lead the company effectively.

I have long advocated that corporate boards and senior executives should attend annual mandatory training programmes. They have to understand exactly what the law requires or prohibits, how the company is addressing these issues and what questions they should be asking to ensure compliance. Training a board is about more than explaining the basic building blocks of a compliance programme – it is also about their role and their accountability for the performance of the company’s compliance programme.

Fault for the current lack of education rests squarely in the laps of board members, senior executives and the chief compliance officer. Board members and senior executives are busy professionals and many think that they are

experienced enough not to need more training.

But, unless a board member happens to have prior experience in compliance, each board member will need to learn how to oversee and monitor a compliance programme.

Embrace a new dynamic: the CCO’s role

For years, lawyers have played a key role in corporate governance by directing boards to play a largely defensive role. Thus, corporate boards are focussed on worst-case scenarios as a guiding principle to escape potential liability.

I am not advocating that lawyers be escorted out of the boardroom, only that the ‘defensive’ approach be replaced with a more realistic balancing of governance principles and risks.

One key principle underlying improved board performance and responsibility is independence. Corporate boards are no longer under the domination or control of powerful CEOs; instead, corporate boards are developing into independent and resourceful leaders

Michael Volkov

CEO and owner of The Volkov Law Group

In this balancing act, however, the need for attention to corporate culture and reputation has been diminished. Lawyers tend to resist change and in particular can become threatened when new influences start to appear in the boardroom. Lawyers must make room at the table for chief compliance officers (CCO) in order to promote and enhance the company’s culture of ethics and compliance.

Giving CCOs a seat at the boardroom table can help lead the board to a new standard of care that embraces the company’s culture, reputation, and oversight of programmes and relationships key to ethics and compliance.

Into the future

Corporate boards are playing a greater role in the oversight and management of company activities. This increased responsibility comes with significant risks. Some corporate boards are requesting more information and reports from senior management and attempting to be better informed and make better decisions, but we still see significant failures all too often.

The US Department of Justice has been emphasising its focus on prosecuting culpable individuals when criminal wrongdoing occurs.

As part of this effort, both it and the Securities and Exchange Commission are looking squarely at board members and senior executives to hold them accountable for failing to act responsibly and prevent wrongdoing when it occurs. Companies and boards need to make sure they have the infrastructure in place to support effective board governance – the risk is too great to ignore any longer.

LACK OF KNOWLEDGE Sometimes board members do not even understand what the law requires of them

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Winter 2017 | Ethical Boardroom 15

Commentary | Transparency

Business can earn a licence to lead

Society is rewriting the rules around what being a ‘responsible company’ means.

How do you go from a resource taker to a market builder and still generate value?

Political upheaval, technological disruption and environmental constraints are making the business environment more complex and less predictable than ever before, posing new challenges for strategic orientation and decision-making. Underpinning these developments are long-term trends – often unfolding in small but cumulative increments – that are reshaping the business environment and the role of business in society.

Recognising these trends and acting in a timely fashion can help to build adoptive flexibility and safeguard survival and growth.

They flow from and are related to changing political regimes, social, environmental and technological changes. And as the world enters a new era, following several decades of market liberalisation and global integration, the following three trends are especially relevant at this juncture.

From horizontal integration to vertical rivalry

The system that was created from the ashes of the Second World War and the rule-based liberalisation that has shaped policy making across the globe following the fall of the Berlin Wall is now being eroded. Ethnic nationalism and a narrowing interpretation of national interests are influencing decisions in many parts of the world. The idea that shared responsibility and common rules are the foundations for managing interdependencies is no longer high on political agendas. Instead, zero-sum game thinking is the new populist gospel. Protectionism is on the rise and bilateral and regional agreements are replacing global rules. The changing political context has been in the making for several years already and its full implications for business are not yet clear.

In continuing to spread technology and wealth, business now needs to develop

16 Ethical Boardroom | Winter 2017

Georg Kell

Vice Chairman of Arabesque Partners a new narrative: from resource taker to market builder. The era of building low-cost supply chains and accessing cheap labour and resources must now give way to a new approach, based on localisation.

Using technology to manage greater decentralisation while showing economic benefits for local economies, such as job creation and good social and environmental stewardship, is vital. Businesses that aspire to compete everywhere will also need to ensure that highest environmental and social standards are practised everywhere, upholding universal values.

Environmental externalities will increasingly be priced

Another profound game changer is being driven by the dawning realisation that human impact on the natural environment may threaten our basis for healthy and secure survival. The rapid degradation of our natural environment, such as loss of biodiversity, pollution of the oceans and the massive dumping of greenhouse gases into our thin and fragile atmosphere, is increasingly showing that we need new business models and a transformation of our energy systems. Contrary to the belief that they are unlimited, natural assets, such as water and the air, now need caretaking.

The Paris Agreement on climate change and numerous national and sub-national actions point to the growing tendency to use market mechanism to accelerate changes. This means that natural assets which used to be considered as free public goods will increasingly be priced.

For business, this means that the adoption of rescource-friendly, low-carbon technologies, including new concepts, such as the circular economy, become a factor for competitiveness. As resource constraints and the mounting implications of climate change affect societal choices, the challenge and opportunity is there to innovate for the future.

Radical transparency is here to stay

The spread of technology and improving analytics to handle big data is today causing disruptions across all industries, offering new opportunities for solving many challenges.

This will have fundamental implications for how business conducts itself, how it is governed, and how it relates to customers and citizens. Indeed, there is nowhere to hide anymore. Corporations have been responding to this trend for a few years now, disclosing information beyond their financial performance. This company data was initially about ‘doing good’ and the building of a narrative to improve the brand. But over the years the quality of data and transparency has improved and more and more businesses are trying to measure and disclose environmental, social and governance (ESG) issues that matter.

According to the Global Initiative for Sustainability Rating (GISR), there are currently more than 500 rating products on the market. In 2011, only 20 per cent of S&P 500 companies disclosed such information.

Today, more than 80 per cent do so and most of them are externally certified. There is still much incoherence and there remain many data gaps, but already it is possible through smart algorithms and systematic approaches to establish a strong correlation between sustainability performance and value generation. A 2015 report published by Arabesque and the University of Oxford, analysing more than 200 academic sources and industry studies, revealed that 80 per cent of them showed a direct link between stock price performance and good sustainability practices.1 Some investors are already making use of ESG information to make smarter decisions.

As the quality of ESG data improves even further, the business case for transparent and sustainable practices is destined to become the new normal. ESG will do to the world of finance what the X-ray did to medicine.

With technological change irreversible, the rise of transparency will increasingly put a premium on those businesses that effectively integrate ESG factors into their strategies and operations, and which measure and disclose

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Transparency | Commentary

accordingly. It will also challenge businesses that fail to adapt. Governance, corporate culture and leadership in an era of radical transparency will need a strong, ethical foundation and a purpose-driven orientation that connects with the zeitgeist.

In response to these trends, businesses have already started to change. Over the past two decades a growing number of companies have gradually embraced strategies and practices under the banner of ‘corporate social responsibility’, ‘sustainability’ and ‘shared value’. The growth of the UN Global Compact – the world’s largest corporate sustainability initiative – from 47 participants at its creation in 2000 to more than 9,000 participants from more than 150 countries today, exemplifies this trend. Many of these corporations are still at the early stage of change. But a growing number are now bringing ESG issues right into the boardroom; introducing new policies and integrity measures, accounting for externalities, and embracing transparency to foster innovation and more direct relations with customers and investors. Furthermore, financial markets have started to pay attention to these issues. The UN-backed Principles for Responsible Investment (PRI), launched in 2006, today has more than 1,600 members, ranging from large asset owners to small service providers, with many ongoing efforts to better integrate ESG information into analysis and decision-making.

While these developments are encouraging, too many companies are still operating on the assumptions of the industrialisation era, treating workers as a commodity and polluting the environment without concern for the common good. As the framework conditions for business success continue to rapidly change however, more companies will embrace good ethics, social responsibility and environmental stewardship so that responsible and sustainable practices become the new norm.

Will this shift happen fast enough to counter the risks we face in our era of uncertainty? The race is truly on. Business leaders can now earn a licence to lead by accelerating this shift. By doing so, they will not only secure their own future. They will also contribute to humanity’s shared aspiration of peaceful co-existence and prosperity.

Governance, corporate culture and leadership in an era of radical transparency will need a strong, ethical foundation and a purpose-driven orientation that connects with the zeitgeist

http://www.arabesque.com/index.php?tt_down =51e2de00a30f88872897824d3e211b11

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Winter 2017 | Ethical Boardroom 17

Commentary | ESG

Michelle Edkins

Managing Director, Global Head of Investment Stewardship, BlackRock

Rise of investor interest in ESG Environmental and social factors are not just of interest to a minority. They are being widely used as indicators of whether a board’s up to its job There’s a slow but steady change afoot in the investment world, namely an increasing awareness of, and interest in, environmental, social and governance (ESG) factors as investment-relevant indicators of management quality. Some companies acknowledge this shift but many still believe that ESG factors are only of interest to specialist ‘sustainability’ investors.

They are wrong. An emphasis on investing for the long term, changing client and societal expectations, and better data, reporting and research have all influenced a steady mainstreaming of ESG considerations by investors. We expect this to gain momentum, which has implications for boards.

The ESG lens

Like the rest of the business world, the investment profession has its own language.

In the case of ESG considerations this has created a language barrier between investors and companies. Most companies would not talk about their ESG risks and opportunities.

Governance – how the company is led and

managed – has long been accepted as an area of interest to, and for discussion with, investors given its clear influence on long-term shareholder returns. But ‘E&S’ is not how business leaders necessarily think about their day-to-day activities. They are more likely to talk about strategic and operational factors, some of which may have an environmental or social component.

For example, a company whose production process is heavily dependent on water and which is operating in a water-distressed location is going to invest to ensure its production is as efficient as possible. This is not necessarily in response to environmental concerns but because of the business reality that water scarcity challenges its ability to operate. The mainstreaming of ESG factors reflects an enhanced awareness investors have of the impact such considerations can have on long-term financial returns because the companies that manage them well generally have high-quality management striving for operational excellence.

What’s driving the change?

Investors are data-driven. The many initiatives focussed on increasing corporate transparency of ESG factors have improved the availability and quality of the information for investors.

Those such as the Global Reporting

Initiative and the International Integrated Reporting Council provide a framework for reporting that provides comparable, quality data over time.

That has further prompted investment research providers to create ESG-oriented reports and tools for their clients. As corporate disclosures have been repackaged to be readily used in investment decision-making, and technology makes other public data more accessible, it has become clearer to investors how to use ESG factors in assessing management quality.

Despite these developments, the quality of reporting by most companies falls a long way short of providing a clear narrative of the strategic and operational impact of the relevant ESG factors inherent in a business.

The regulatory framework for such reporting is piecemeal, inconsistent across markets and seldom enforced. There is no globally recognized reporting

SUSTAINABLE INVESTMENTS Investors are seeking to put their money to work with purpose

18 Ethical Boardroom | Winter 2017

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ESG | Commentary

framework comparable to the International Financial Reporting Standards, resulting in a laissez-faire approach. It took decades to establish a robust financial reporting framework. The work of the Sustainability Accounting Standards Board, among others, to create a comparable system for corporate reporting of relevant, sector-specific ESG factors means we should expect investor use of such data to increase as quality improves.

How do investors factor in ESG? Mainstream investors will have a range of approaches to how they factor ESG

considerations into their investment strategies.

At BlackRock, we have three main approaches – impact investment strategies, ESG integration and stewardship.1 We offer clients who have clear objectives for investing for both financial and E&S outcomes a set of specific investment products that are constructed to meet that end.

To enable investment analysts on our active portfolios to take relevant ESG factors into consideration in their investment analysis, we have integrated ESG data into our risk and investment management platform. That data, corporate reporting and third-party research is also used by our investment stewardship team to engage with companies on their governance and how they manage the environmental and social risks and opportunities in the business.

The implications for directors

The likely implications for directors are three-fold: a greater need to understand operational excellence as it pertains

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to ESG factors, a stronger focus on ESG reporting, and a different set of skills required in the boardroom.

The role of the corporate board director has evolved steadily over the last few decades.

The focus on corporate governance, often spurred by the implementation of market-level codes, has led to increased expectations and scrutiny of directors. A recent survey of US directors indicated an average annual time commitment of about 250 hours per board.2 This is likely to increase, as only 41 per cent of respondents felt that their board was strong on addressing long-term risks related to economic, technological, geopolitical and environmental trends. If investors are monitoring corporate performance on ESG and other factors that have an economic consequence in the long-termer, directors will need to have a deeper understanding of how these factors are being managed. Among other things, this may require site visits, additional board meetings with a focus on those factors so directors can hear from operational management about how they are being addressed, or the formation of a dedicated board committee. Directors might also seek out the research that investors are using to assess performance on the ESG factors relevant to the company and ensure they understand how it is used by investors and how management views the analysis. 3 Directors need to be more focussed on the quality of corporate reporting on ESG factors.

Done well, such reporting should provide a strategic narrative around ESG factors, supported by data, that explains for investors the business risks and opportunities and how these impact operations, strategy and long term financial returns. Directors should also ensure that the board has a crisis response plan consistent with supporting management to remedy adverse events.

A heightened focus on ESG factors may also affect board composition. Directors need to be fluent enough in the issues to oversee and counsel management. Fluency will also be expected by investors interested to engage with directors to understand how the board oversees and counsels management on key strategic and operational decisions that have

a social or environmental component.4 Directors should bring a range of skills and experience to the boardroom. However, just as there is now demand for experienced business leaders with cybersecurity knowledge to join boards, it seems likely that demand will increase for directors with experience of E&S factors, such as supply chain control, climate risk or human capital management. Those boards that don’t currently have sufficient expertise on relevant E&S matters may need to undertake a comprehensive evaluation and succession exercise to remedy the shortfall.

Anticipating the future

Boards play an important role in shaping the long-term economic success of companies.

With a greater scrutiny of how companies do business, board directors will need to

The quality of reporting by most companies falls a long way short of providing a clear narrative of the strategic and operational impact of ESG factors inherent in a business demonstrate that they are savvy about ESG factors. As in many significant shifts in practice over time, the pace of change seems painstakingly incremental until suddenly everyone is of the view that ‘we’ve always done it this way’. The adoption by investors of ESG factors as indicators of management (and board) quality is slowly gaining momentum.

Directors who anticipate this change and ensure that they and their boards are prepared for it will be doing themselves and their companies a great service.

1 www.blackrock.com/corporate/en-us/literature/ whitepaper/viewpoint-exploring-esg-a-practitionersperspective-june-2016.pdf. 2 PwC, The Swinging Pendulum: Board governance in the age of shareholder empowerment, October 2016. 3 For examples, see research from MSCI ESG Manager, Sustainalytics, UBS, HSBC (on climate especially), GS Sustain or Bank of America Merrill Lynch. 4 For more on board engagement on ESG matters, see www.ceres.org/ resources/reports/view-from-the-top-how-corporateboards-engage-on-sustainability-performance

Winter 2017 | Ethical Boardroom 19

Commentary | New US Presidency

Michael Moran & Jonathan Wood

Michael is the Principal and Chief US/Macro Analyst; Jonathan is the Director of Global Risk Analysis, Control Risks

The Trump effect Republican candidate Donald Trump was elected the next president of the United States on 8 November 2016. Unlike his opponent, Hillary Clinton, Trump did not comprehensively outline his domestic and foreign policies.

As a result, there is considerable uncertainty about which policies he will pursue in office and how aggressively he will do so.

In this article, we explore how the incoming administration is likely to approach and influence global and regional politics and how foreign governments are responding to the election result.

Global implications

Trump’s successful campaign leveraged the anti-establishment, populist trend in Western politics, and expressed the US’s underlying nationalist and isolationist tendencies – particularly concerns about immigration and trade – which may close a 25-year period of liberal internationalism in its foreign policy.

Trump spoke of imposing unilateral tariffs on major trading partners to obtain more favourable terms of trade and strengthen US manufacturing. He also opposes new trade 20 Ethical Boardroom | Winter 2017

What the world can expect following the historic 2016 US presidential election agreements and favours renegotiating existing agreements, such as the North American Free Trade Agreement (NAFTA). Furthermore, his election effectively kills pending and prospective trade and investment agreements, including the Trans-Pacific Partnership (TPP) with Asia and the Transatlantic Trade and Investment Partnership (TTIP) with the EU. This would have a strongly negative impact on both the US and global economies, including as a result of retaliation by trade partners.

Trump embraces a nationalist, unilateralist and transactional foreign policy. It revolves in part around securing adequate compensation to maintain US military deployments abroad.

He also advocates a more confrontational posture towards China and other emerging market manufacturers on trade.

He has signalled a greater tolerance of Chinese and Russian regional ‘spheres of influence’. As a result, a less interventionist US will create further space for rising powers to develop diplomatic, military and economic influence worldwide.

Trump has stated that he would withdraw from the UN climate accord, which came into effect in October. He has also stated that he would reverse the Obama administration’s domestic regulation of emissions, coal power, and oil and gas extraction. Termination of these regulations would substantially reduce, if not eliminate, the incentives for other major emitters to uphold their own climate change commitments. Furthermore, while less regulation would benefit US fossil fuels, the impairment or collapse of the UN climate accord would inject significant instability into the market for green technology. Some nations, including China, have stated though that they will sustain their commitments and sub-national bodies in the US and elsewhere are taking independent and significant action, regardless of national level commitments.

Regional implications

Asia: Beyond China, Japan and South Korea, Asia did not feature strongly during the presidential campaign and is unlikely to be a major early focus of the Trump administration. Nonetheless, US policy shifts will reverberate across the region.

Trump’s signature trade policy – threatening unilateral tariffs to extract more favourable terms of trade and strengthen US manufacturing – squarely targets China. A trade confrontation would be likely to invite www.ethicalboardroom.com

New US Presidency | Commentary there is no doubt that US-Russia relations will change, we would caution against some of the more extreme reactions. Much of what Trump represents is old news in Europe, and much of the rest might be difficult to translate into actual policy.

Latin America: Central and South America are likely to receive little attention from the new administration, with probably few significant changes in policy. Only Mexico faces considerable economic and political uncertainty in light of likely efforts to renegotiate NAFTA, as 80 per cent of Mexican exports go to the US. US aid to Central America, particularly the ‘Northern Triangle’ countries of Honduras, El Salvador and Guatemala, has been a key prop for those countries, and the new administration will be anxious to avoid cuts to programmes that are designed to tackle the root causes of immigration to the US. The Trump campaign’s anti-Cuba rhetoric hardened as the campaign wore on, but we do not anticipate all the political and commercial openings pursued by Obama to be rolled back.

POPULIST PRESIDENT Trump swept to office on a wave of anti-establishment sentiment

Illustration by Brendon Ward www.inkermancreative.com

Chinese retaliation against US exports, with US companies in China potentially caught in the crossfire.

Trump has stated that he would withdraw from TPP immediately on entering office.

Therefore, the Association of South East Asian Nations (ASEAN) signatories can no longer count on enhanced US market access, and significant political capital invested in the deal – particularly in Malaysia and Vietnam – could be squandered.

The US will re-evaluate US regional alliances and is likely to withdraw from regional territorial disputes in the East and South China Seas, encouraging US allies like the Philippines and Thailand to balance US uncertainty with warmer China relations. The new administration also seeks a more transactional security relationship with Japan and South Korea, which might encourage them to ‘self-insure’ by developing new defence capabilities, including nuclear weapons.

states to legitimise their own socially conservative and nationalist policies.

The UK may find itself in a slightly stronger position with regard to trade with the US. Bilateral trade talks with the new administration could represent a serendipitous chance to strike a huge early success in the Brexit era and establish a model for the next generation of trade agreements.

Trump’s commitment to NATO was notably uncertain during the election campaign. In addition, the new administration is likely to

Europe: Europe is likely to seek pragmatic accommodation with the incoming administration, even as Trump’s victory serves as inspiration for an array of populist movements fighting elections in 2017, such as in France, the Netherlands and Germany.

In addition, the president-elect’s rhetoric tends to resonate well among some of the leaders in Central and Eastern European

seek to improve relations with Russia.

This will inevitably cause disquiet, particularly in the Baltic States, not least because the administration may well put NATO Article 5 – committing members to mutual assistance – on the table.

Trump’s election changes the state of play between Europe and the US, particularly in terms of relations with Russia. However, while

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Trump’s signature trade policy – threatening unilateral tariffs to extract more favourable terms of trade and strengthen US manufacturing – squarely targets China

Middle East and North Africa: The incoming president expressed views on a range of issues pertaining to the Middle East and North Africa, among them new threats to the integrity of the Iran nuclear deal (JCPOA) and the probability of re-imposing sanctions against Iran. He also advocated a robust US military posture against the so-called Islamic State (IS), including US military operations in Iraq and Syria in close cooperation with Russia and other actors.

Trump’s position on Israel is perhaps his most well-defined with regards to the region.

In particular, he expressed support for moving the US embassy in Israel from Tel Aviv to Jerusalem (signalling potential recognition of Jerusalem as the Israeli capital), for vetoing any proposed peace agreements at the UN, and for unconditional peace negotiations (which the Palestinians reject).

The wider uncertainty about the durability of US security and geopolitical commitments would encourage regional players – chiefly Iran, the Gulf States and Turkey – to continue pursuing more independent foreign and security policies, as well as new diplomatic and trade relationships, intensifying regional competition.

Sub-Saharan Africa: Africa did not feature significantly during the presidential campaign. We expect the most significant impacts for African countries will come through three aspects of the new administration’s policy: curbing free trade, cutting aid and pursuing alliances that fit US strategic security interests.

However, potential US trade disputes elsewhere could create opportunities for some African countries with low-cost labour forces and preferential trade access.

Winter 2017 | Ethical Boardroom 21

Global News Europe

HSBC supports diversity in Malta’s boardrooms HSBC Bank Malta has signed up to the new Women Directors Malta (WDM) charter, which aims to improve diversity in the country’s boardrooms. The share of women on boards in Malta stands at just 2.5 per cent, below the European average of 21.2 per cent of board members of the largest publicly listed companies.

HSBC’s Malta CEO Andrew Beane said: “Leaders in the corporate sector must have the courage to stand up and change the status quo as it is clear that diverse companies perform better and in today’s world gender inequality is simply unacceptable.

“At HSBC Malta we already have five female directors across our three companies and a further three female colleagues on our executive committee. Despite these talented women having reached the highest levels of HSBC, we have a lot more work to do to ensure we have a strong and diverse future as a company.”

Sports Direct CEO slams shareholders

Mike Ashley (above), the founder and chief executive of Sports Direct, has criticised the company’s shareholders after they refused to back the re-election of Keith Hellawell as chairman.

A number of major shareholders and financial institutions, including Standard Life, Royal London, Hermes and Aberdeen Asset Management, have opposed Hellawell’s re-election.

Shareholders said Mr Hellawell did not warrant support because he “has overseen a period of serious operational, governance, and risk oversight concerns which have materially affected the company’s outlook and damaged shareholder value”.

However, Mike Ashley said supportive comments about Hellawell from hedge fund manager Crispin Odey were “highly significant at a time when others have been less forthcoming” and that they were “in agreement over the fact that Keith Hellawell is the right man to help deliver further progress”.

22 Ethical Boardroom | Winter 2017

Novartis linked to alleged pharma scandal The Greek government has launched an official investigation into Novartis, one of Switzerland’s largest pharmaceutical companies, following bribery allegations.

According to local media reports, Novartis had paid bribes to Greek civil servants and doctors in order to encourage sales of its drugs in the domestic market.

Swiss news agency ATS reports that 178 people have so far been interviewed over claims that discounts were offered by Novartis to civil servants or doctors.

Novartis said it is “cooperating with the demands of authorities” and is “committed to the highest standards in matters of ethical business conduct and regulatory compliance in all aspects of its business”.

RBS investors want improved transparency

Shareholders have called for Royal Bank of Scotland to create a shareholder committee to prevent a return of its near-collapse in 2008 and strengthen the state-owned lender’s corporate governance.

Groups representing small shareholders, including ShareSoc and the UK Shareholders’ Association (UKSA), say they should be involved in “scrutinising remuneration and other key corporate issues, such as long-term strategy and directors’ appointments”.

ShareSoc and UKSA have presented RBS with a resolution for the proposal to be included on the agenda at the bank’s annual general meeting in May, where investors would then be given the chance to vote on the measure.

FRC wants to tackle corporate governance The Financial Reporting Council (FRC) has asked the government for more oversight powers in order to tackle corporate governance issues.

The UK’s audit and governance watchdog’s annual Developments in Corporate Governance and Stewardship 2016 Report argues that more can be done to “improve trust in business and promote a strong economy”.

The FRC said it stands ready to revise the UK Corporate Governance Code in 2017 and wants more focussed reporting by boards on how they discharged their responsibilities.

Paul George, executive director of corporate governance at FRC, said: “The Code is 25 years old. It has served the UK well. We must continue to ensure that business behaviour, underpinned by strong and respected corporate governance principles, develops over the next quarter of a century and beyond.” www.ethicalboardroom.com

Optimise the effectiveness of your board and meet your European peers

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*ecoDa represents the main national institutes of directors in Europe http://ecoda.org/members/ ecodas-members/list-of-members/

Topics include: ➤ Overview of different Corporate Governance models in Europe ➤ Mega trends in EU boardrooms ➤ Trends outside the EU ➤ Challenges, benefits and risks of being a director in Europe ➤ Simulation of a real boardroom in cooperation with INSEAD, our academic partner

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Dr. Roger Barker is a consultant specializing in Corporate Governance and Board Effectiveness. Between 2008 and 2016, he was Director of Corporate Governance and Professional Standards at the Institute of Directors (IoD). In October 2015, he was appointed as a UK representative on the European Economic and Social Committee, the EU consultative body.

He is Senior Consultant at the Institute of Directors.

Cover Story | Red Eléctrica

AWARDS

WINNER 2017 EUROPE UTILITIES José Folgado

Chairman, Red Eléctrica

Red Eléctrica: Switched on to good governance The Spanish electricity system operator is committed to ethics, integrity, transparency and good governance Red Eléctrica has been recognised in the Ethical Boardroom Corporate Governance Awards 2017 for the best corporate governance of European companies in the utilities sector.

For Red Eléctrica, the award is testament to the company’s firm and continued commitment to best corporate governance practices and to developing a model based on ethics, integrity and transparency.

Since its creation in 1985 as transmission agent and operator of the Spanish electricity system, Red Eléctrica has been determined to use its role to serve society, making the adoption of best corporate governance practices an integral part of its objectives since it was first listed in the stock exchange in 1999.

This has been made possible not only by complying with the relevant legal regulations, but also by gradually implementing, in a proactive and voluntary manner and fostered by its board of directors, certain relevant practices, measures and initiatives in corporate governance that had been recommended by its shareholders (in particular, foreign shareholders; which represent almost 70 per cent), investors and the markets.

The Red Eléctrica Group establishes in its corporate governance policy the values that govern its relationship with the various 24 Ethical Boardroom | Winter 2017

stakeholders, in all areas of its activity, and that contribute to the achievement of strategies and to the sustained maximisation of value of the company.

These values are linked to reliability, responsibility, respect, leadership and creativity, and environmental awareness.

On the road to excellence

This policy seeks to align the interests of the company with those of its shareholders and other stakeholders by protecting and promoting shared value for all; value that incorporates criteria within the economic, social, environmental and good governance scopes, not only to contribute to the sustainability, solvency and good reputation of the Red Eléctrica Group, but also to reinforce confidence, stability, progress and social and economic development.

The two activities of Red Eléctrica, the construction and maintenance of the high-voltage grid, on the one hand, and the operation of the electricity system, on the other, are key to guaranteeing the security and quality of the electricity supply and, consequently, the wellbeing of citizens.

Its activity, with the installation and commissioning of lines and substations, has a direct impact on the territory, so it is imperative to achieve maximum involvement and cooperation of public administrations and to pay special attention to the protection of natural capital through the application of environmental and social measures. This

STABILITY, PROGRESS AND INNOVATION Chairman José Folgado is committed to improving corporate governance

implies the integration of communication channels and establishing management systems capable of responding to the requirements of the various stakeholders.

The activities carried out by the company to maximise the integration of renewable energies into the electricity system and for the improvement of energy efficiency are essential for the achievement of European sustainability objectives and to respond to the social demand for an increasingly sustainable energy model.

Of particular note is the work performed by the Control Centre of Renewable Energies (CECRE), a pioneer centre that has contributed to the fact that, on average over the last three years, 40 per cent of the electricity demand has been covered by renewable energies. In addition, in line with its strategy to combat climate change, Red Eléctrica has launched a climate change www.ethicalboardroom.com

Red Eléctrica | Cover Story Similarly, the company’s healthy workplace model constitutes a strategic commitment to the management, promotion and monitoring of the health and wellbeing of the people who make up the company. Thus, various initiatives have been carried out in this field related to the promotion of health, the work-life balance, and the prevention of occupational risks in the workplace. These commitments undertaken by the company contribute to improving the involvement of workers in the business project.

The company structures its commitments in the field of corporate responsibility through multi-year plans and annual programmes, both approved by the appointments and remuneration committee of the board, whose fulfilment has been linked since 2015 to management goals and the long-term objectives of the company’s management team. Many of the commitments made by Red Eléctrica in these programmes contribute to the achievement of the 17 Sustainable Development Goals approved in September 2015 within the framework of the 2030 Agenda of the United Nations.

Red Eléctrica’s corporate governance policy seeks to align its interests with those of its shareholders and other stakeholders by protecting and promoting shared value for all POWER CHANGE On average, 40 per cent of electricity demand is met by renewables

action plan that incorporates the challenge of reducing or offsetting 21 per cent of its CO2 emissions compared to the values of 2010.

Another fundamental aspect in corporate responsibility is the firm’s backing for talent and its commitment to gender equality and opportunities, as evidenced by the fact that the vast majority of appointments to director positions that took place in the Group in 2015 were covered through internal promotion.

Also noteworthy is the increase in the number of women in the workforce and in management positions, as well as the creation of a Women’s Leadership Observatory whose objective is to propose actions to increase the presence of women in management positions. An important fact in this regard is that, in 2015, 31 per cent of the people who reached management positions through internal promotion were women. www.ethicalboardroom.com

WORLD LEADING The company’s pioneering Control Centre of Renewable Energies (CECRE)

Winter 2017 | Ethical Boardroom 25

Cover Story | Red Eléctrica All the above has made it possible for the company to renew its presence in both the Dow Jones World Sustainability Index and the European Sustainability Index as well as other sustainability indices. Similarly, the company has maintained the European Seal of Excellence 500+ according to the EFQM model, obtaining more than 700 points, which ranks it among the best valued companies in Europe and the world. Other recognitions have been: RobecoSAM’s Sustainability Yearbook; IISR Survey; CSR Observatory; RSE Observatory; Commitment and Transparency Foundation; Carbon Disclosure Project; FTSE4Good, and Euronext-Vigeo.

In this regard, the Chairman of Red Eléctrica, José Folgado, says: “We are convinced that good corporate governance contributes to the economic, environmental and social sustainability of the company, and thus to the stability, progress and social and economic development of our world. We are prepared for this. We have a team of people committed to innovation, excellence, quality and the corporate values; being this human factor a decisive element in paving the way for a brilliant performance in the coming years. We also have instruments in the areas of the work-life balance, training and promotion that allow us to establish a favourable working climate. This is how the levels of productivity are increased, which must be justly compensated. These measures also contribute to the pride we feel in belonging to this great company.”

Good practices in corporate governance

The award now granted by Ethical Boardroom highlights the important role that corporate governance plays in the creation of long-term value of the company.

Regarding the most recent practices undertaken by Red Eléctrica in this field, noteworthy was the process of the separation of the positions of chairman and CEO, which responds to the commitment undertaken by the board of directors and its chairman to adopt the best international practices in the field of corporate governance. The separation of the positions of chairman of the board of directors and chief executive officer of the company was submitted for approval at an Extraordinary General Meeting held in July 2015, and was completed in the last General Shareholders’ Meeting held in 2016, with the full separation of duties between both positions.

In addition to this process, despite it being on longer mandatory in Spain, the company has maintained the role of the lead independent director created in 2013, as the board considers that the responsibilities attributed to this role continue to provide value, efficiency and balance to the functioning of the board, as recognised by foreign shareholders and proxy advisors.

For chairman José Folgado, with the separation of positions, Red Eléctrica has 26 Ethical Boardroom | Winter 2017

GLOBAL ROLE Chairman Folgado says Red Eléctrica has a leading part to play in society

fulfilled “a highly significant commitment made to its shareholders and which responds to the principles of anticipation, voluntariness and absolute transparency, included in the corporate governance policy of the company”.

Another example of the leadership of the Group in corporate governance is the promotion of gender diversity on the board of directors. Since 2009, Red Eléctrica has been ranked in the top positions of the IBEX 35 (main benchmark stock market index of the Spanish stock exchanges) in relation to the presence of women on its board (currently more than 36 per cent of the board). This commitment to gender diversity and equality is firmly maintained throughout the organisation.

The principles envisaged in Red Eléctrica’s corporate governance policy in the field of appointments ensure adequate procedures for the selection of board members to ensure a reasonable balance and diversity in the board of directors for the adequate performance of its mission and responsibilities.

Regarding the board’s remuneration policy, a practice also highlighted, Red Eléctrica maintains a transparent model based on moderation and which is linked to the responsibilities assumed and the effective dedication of board members.

This model, which is aligned with the strategies and long-term interests of the company, its shareholders and other stakeholders, always takes into account the www.ethicalboardroom.com

Red Eléctrica | Cover Story remuneration established by comparable companies and has incorporated for years, as a consolidated practice, the voluntary submission to the approval of the shareholders’ meeting of all proposals regarding the remuneration of the board. This remuneration policy aims to encourage the work of the board member without conditioning their independence when making decisions.

The permanent commitment to shareholders, investors and other stakeholders is another of the pillars of corporate governance of the company, which develops and fosters symmetrical dialogue mechanisms as well as dissemination and communication actions, in order to improve relations, increase sustainable commitment and strengthen trust in the company.

In application of this value, Red Eléctrica provides its shareholders with homogeneous and systematised information that reflects that the environmental, social and corporate governance objectives (ESG) are part of the social interest. As proof of this, these types of objectives have been incorporated into the annual and multi-year variable remuneration of the CEO and the management team.

But in addition to the management of all the principles included in the corporate governance policy, for Red Eléctrica it is essential to guarantee transparency and maximum information quality; hence its special dedication to presenting, in a clear, simple and understandable way for its stakeholders, all information on corporate governance through its dissemination channels and, especially, through its corporate website, which undergoes ongoing reviews, updates and improvements of its content and structure following international standards.

Proof of this transparency and quality of information is the recent publication on its website of the company’s ‘Governance Story’, SEAT Of POWER Red Eléctrica's head office is comprised of four buildings in Madrid

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which includes the main milestones since it was listed on the stock exchange in 1999.

In a very graphic and visual way, it shows in detail the road travelled, the evolution and progress to date of the commitment of the board of directors for the implementation and continuous improvement of good governance in the company.

Integrity model of the Group

Red Eléctrica considers ethics, integrity and transparency as fundamental pillars for the proper functioning of its business activity and for carrying out the legal duties and responsibilities entrusted to it. This means acting with the utmost integrity in the fulfilment of its obligations, relationships with and commitments to its stakeholders.

We are convinced that good corporate governance contributes to the economic, environmental and social sustainability of the company and thus to the stability, progress and social and economic development of our world For the undertaking and defence of these principles, Red Eléctrica has a series of corporate guidelines that establish the values and performance criteria that must be assumed by all the people that make up the Red Eléctrica Group in the execution of their professional activities.

One of the main guidelines is the Code of Ethics, whose first edition dates from 1987 and the most recent one from 2013, and whose objective is to provide an ethical and business conduct guide to the managers and employees of the Group, which sets out the values and commitments that should govern their actions. Similarly, it seeks to take on board the requirements demanded by stakeholders and the recommendations of organisations of repute in this field.

Red Eléctrica has appointed an ethics manager to channel the doubts that may arise in application of the Code and to collate, analyse and resolve grievances received. The ethics manager, with direct reporting to the chairman and, if applicable, to the board of directors, maintains the confidentiality of processes at all times and is responsible for the development, consolidation and continuous improvement of ethical management in the Group.

Since the approval of the current edition of the Code, a plan for raising awareness around ethical management has been developed.

Within the framework of this plan, awareness and discussion sessions have been held in all work centres, aimed at improving the

knowledge of the ethics management system within the organisation.

Red Eléctrica also has a specific code applicable to its suppliers, which requires them to respect human rights, equality and the integration of people with disabilities, as well as the need to comply with environmental and occupational health & safety requirements.

The company also has a criminal risks prevention programme that aims to identify the rules, procedures and tools established in the Group to prevent the breaching of the legal regulations that may carry criminal implications applicable the organisation as a legal entity.

In addition to these rules of business conduct, in 2015 the board of directors also approved the guide for the prevention of corruption that develops corporate values and behavioural patterns contained in the Code related to the main manifestations of corruption.

Future plans regarding corporate governance matters

The commitment does not end here. As Red Eléctrica’s chairman points out: “It is necessary to incorporate new and better actions, because there is always a new challenge, a better way of doing things, a more adequate response to a request, even to those that have not yet been suggested.”

Among the relevant issues being discussed by the board of directors and its committees, noteworthy is the recent adaptation of the regulations of the board of directors to the latest legal reforms, corporate governance recommendations and the process of separation of the positions of chairman and CEO; the finalisation of the revision of the succession plan for the chairman of the board and the new succession plan for the CEO; the development of the board’s new annual self-assessment process with external support, and the strengthening of internal control and risk management functions, including the completion of the development and implementation of the new compliance system.

Other issues in which the board of directors considers it important to persevere, in order to strengthen its culture of good governance, are the consolidation of the remuneration policy and structure in accordance with the principles of moderation, transparency and comparability; the ongoing improvement of the corporate governance information contained on the website; and reaching new milestones in the preparation and publication of the annual information addressed to shareholders or other stakeholders under the principles of quality, clarity, integrity and informational simplicity.

Red Eléctrica firmly believes that continued progress in the field of good corporate governance is a key objective in order to strengthen the trust and ties between the company and its shareholders, through a sustainable dialogue and commitment, for the benefit of all.

Winter 2017 | Ethical Boardroom 27

Activism & Engagement | Passive Investors

Engaging with passive investors Index fund holdings have found their voice... make sure you don't ignore it The giant shift in assets from active to passive investment strategies over the last few years has profoundly changed the balance of shareholder power in corporate America. Index funds managed by investment giants, such as BlackRock, Vanguard and State Street are now more influential than ever. These investors not only own an increasingly large share of US and international companies, but are also becoming increasingly vocal about corporate governance, executive compensation and other vital investor issues.

While companies tend to be primarily concerned, from a defensive standpoint, with activist hedge funds, company managements and boards of directors should take note of large traditional managers and rethink the way they engage with these influential, ‘vocal passive’ shareholders.

The growing role of passive investors is undeniable. From 2008 to 2015, investors moved approximately $1trillion into 28 Ethical Boardroom | Winter 2017

Bruce H. Goldfarb

Founder, President and Chief Executive Officer of Okapi Partners passively managed funds. The $4trillion passive index fund sector is dominated

by BlackRock, Vanguard and State Street.

A recent paper by researchers at the University of Amsterdam estimates that collectively these three investors constitute the largest shareholders in 88 per cent of S&P 500 companies.1 Traditionally, managements and boards of directors may have been tempted to overlook these major shareholders at proxy time, given that index funds’ holdings, while substantial, are relatively stable. It was also assumed that the funds’ primarily passive investment approach implied a passive stance with respect to corporate governance and voting as well. It was almost a given that many of these shareholders would vote with managements’ recommendations or follow the advice of proxy solicitation firms, such as ISS and Glass Lewis.

More assertive approach to adding value

As index funds’ holdings have grown dramatically, the fact that their positions are ‘built to last’ has given them an incentive to become more assertive. These investors recognise that, while they may not be able to use the active management of investment

positions to create value, they can urge companies to enhance value through more investor-friendly policies. In the past few years, this realisation has led BlackRock, Vanguard, State Street and other index fund managers to express a more active – almost activist – attitude toward corporate boards.

All three have issued letters to boards noting an increased focus on corporate governance.

And, in 2015, BlackRock revised its proxy voting guidelines to provide more oversight in board re-elections, especially with regard to issues such as long tenures, board diversity, lack of meeting attendance, and protecting shareholder rights.2 A study published in the Harvard Business Review this year found that the more vocal attitude is having a positive impact: “There is evidence that passive investors are taking these actions with the belief that improved governance will eventually lead to improved performance and, ultimately, shareholder value. Specifically, we found that passive ownership is associated with higher profitability and firm value.”3

Incentive for board engagement The increasingly assertive stance of index fund managers should provide boards with

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PASSIVE, NOT RELAXED Passive managed funds are becoming more assertive

incentive enough to engage with these major investors but there is yet another reason. With the rise of activist investors in recent years – campaigning for everything from board seats, to buybacks, to breakups – it can be vitally important for managements and boards to articulate why their value creation strategies will be more effective than those put forward by the activists. And that requires winning the support of large index fund shareholders, who may be inclined to vote with the activists in more instances than ever before.

Whether a company is facing an activist campaign or not, boards should seize upon the opportunity to engage with these vocal passive investors, understand their views on corporate governance issues and demonstrate how closely the company’s strategy is aligned with the investors’ notions of share value creation. There are several actions that boards can take in this regard.

Know the company’s major investors.

This initiative is a process that should not simply be left up to management, as these large institutions expect the directors to be their representatives in matters of corporate governance policy-setting and decisionmaking. Understanding your shareholder base is an increasingly difficult endeavour www.ethicalboardroom.com

that is constantly changing, especially as more derivatives and other ways of holding shares become used by more market participants.

Understand the interests and views of your passive investors. As I’ve noted, larger index fund managers, such as BlackRock, Vanguard and State Street, are publicly vocalising their beliefs on board refreshment, performance-based compensation and other governance issues. These investors really do not blindly follow the research advice of proxy voting advisory firms; the most effective engagement recognises the unique process of each investor. Your company’s

The growing role of passive investors is undeniable. From 2008 to 2015, investors moved $1trillion into passively managed funds investor relations team and/or outside proxy solicitors can provide additional insights as to what these shareholders care about.

Communicate about what matters to the investors. Using any public statements and the insights from IR/proxy solicitors as a roadmap, be proactive in engaging the index fund investors on the issues of primary interest.

Finally, it is important for directors to recognise that large index fund managers own stakes in literally hundreds of companies and would be overwhelmed if every board wanted a face-to-face meeting. It may be more useful to have a brief phone conversation in which you convey well-articulated and on-point messages about the company’s value creation strategy and corporate governance, rather than an extended meeting. At the same time, a well-crafted proxy statement and compensation discussion and analysis can be a solid platform for such discussions.

Depending on the issues at hand, the board and senior management should determine whether (and how) a board representative should reach out to the investors. You’ll also want to decide which board member(s) are the most appropriate representatives in a given situation: lead director, compensation committee chair, etc.

Again, the IRO or proxy solicitor can provide valuable guidance in this regard. But regardless of how you communicate with vocal passive index fund investors, the most important thing is to ensure that the board is actively, enthusiastically and effectively engaged in the investor outreach process. https://papers.ssrn.com/sol3/papers.cfm?abstract_ id=2798653 2 http://www.businessinsider.com/vanguardblackrock-going-activist-2015-3 3 https://hbr.org/2016/05/ research-index-funds-are-improving-corporate-governance 1

Winter 2017 | Ethical Boardroom 29

Activism & Engagement | Proxy Fights

Proxy fights: Don’t underestimate the risk “We are no target for shareholder activists.” I hear this every other day from small and mid-cap companies (and sometimes even large caps) across the US and abroad, from executive officers, board members and others.

Occasionally this assessment is correct. More often than not, however, it is not. It only reflects common misconceptions.

For example, many companies believe that shareholder activism is on the decline because they no longer read about it in the news all the time. In fact, shareholder activism is as prevalent as ever. There were 233 publicly reported activist campaigns in the US in 2016.

Since many activism situations are resolved outside the public eye, we estimate that the actual number is at least 400 annually.

There are around 4,200 public companies in the US, which means that activists target approximately 10 per cent of corporate America, each year. Many small and mid-cap companies seem to believe that shareholder activism

Five crucial mistakes small and mid-cap companies make in an era of shareholder activism

Kai Haakon E. Liekefett

Head of the Shareholder Activism Response Team, Vinson & Elkins L.L.P affects primarily larger companies. After all, the national media outlets report only proxy contests against the likes of Yahoo! and DuPont.

Nothing could be further from the truth.

Last year, 52 per cent of all publicly reported activism campaigns and 83 per cent of all proxy contests targeted companies with a market capitalisation of under $1billion. In other words: it is high noon for small and mid-cap companies. And yet, many of them don’t realise this and don’t even own a gun – let alone the right types of bullets – for their highly likely showdown with an activist. This article describes five of the most egregious mistakes these woefully unprepared companies are making.

Mistake One: Inadequate charter and bylaws Do you know what your charter and bylaws provide for contested director elections? Most public companies, in particular smaller ones, have hopelessly inadequate organisational documents for proxy fights. The problem is that they all have bylaws that were put in place many years ago, at the IPO stage.

Often these bylaws were drafted by a mid-level capital markets associate who pulled a form and filled in the blanks – but who has never seen a proxy fight. In an activism situation, every word in your bylaws matters and may take on new significance. In our practice, we find at least 10 to 15 mistakes and vulnerabilities in every set of bylaws that we review. For example, 90 per cent of all bylaws allow the board to adjourn a shareholder meeting only in the absence of a quorum. This works just fine in peacetime, but it is unfortunate if the company is in a proxy contest, narrowly behind in the proxy tally and would like to delay the meeting by a few days or even only hours to flip a voter.

The reality is that the organisational documents of most companies have never been reviewed by someone who fights proxy contests for a living. It is critical to retain a

AVOID THE ABYSS Unprepared CEOs are vulnerable in meetings with activists

30 Ethical Boardroom | Winter 2017

www.ethicalboardroom.com

Proxy Fights | Activism & Engagement proxy fight specialist to review a company’s charter and bylaws – and not a regular outside securities counsel who most likely has never been involved in a proxy contest and thus does not know what to look for.

Mistake Two: ‘Shelf’ poison pill is not operational

Most companies do not have an active shareholder rights plan (aka ‘poison pill’) to limit stock accumulations to a certain threshold (e.g. 10 per cent). In the absence of a specific threat, companies are generally advised not to adopt a poison pill because proxy advisory firms (ISS and Glass Lewis) and institutional investors generally oppose poison pills.

The alternative to outright adoption is placing a poison pill ‘on the shelf’. This means that the poison pill documentation is fully drafted and ready for adoption. This enables the board to react quickly in the event an activist rapidly accumulates a stake. Many small and mid-cap companies do not have a shelf poison pill at all – or they have a poison pill that is actually not fully operational. The problem is that most law firms who provide their clients with a shelf poison pill have no experience with adopting them. Therefore, these law firms – let alone their clients – do not even realise that their shelf poison pill does not actually work as drafted and do not understand the practical steps required to adopt it. It often takes them days to adopt a poison pill.

A shelf poison pill that cannot be adopted overnight is a tool than cannot serve its intended purpose when it’s needed most. If it takes a few days, the activist can continue

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adding shares to its already sizable stake and gain further tactical leverage over the company.

Mistake Three: No adequate stock surveillance

Even if a company has a fully operational poison pill on the shelf, its effectiveness as a defence measure is severally impaired without proper stock surveillance.

Most activists quietly amass a significant stake under the radar, called a ‘beachhead’.

Most regulatory reporting regimes contain enough loopholes to enable a dawn raid by an activist. Most notably, in the US, an activist has 10 days after crossing the five per cent threshold

Many companies believe that shareholder activism is on the decline because they do not read about it in the news all the time any more.

In fact, shareholder activism is as prevalent as ever before filing a Schedule 13D with the Securities and Exchange Commission. Shrewd activists use this 10-day window to buy as many shares as possible. For example, recently a company woke up to an initial Schedule 13D filing with a new 25 per cent activist shareholder – and the company had never even heard of the activist before the filing was made.

In an era of shareholder activism, it is therefore important to watch the trading in a company’s stock. Most small and mid-cap

companies do not use a stock watch firm or they use a service that is not paying close enough attention. In fact, most stock watch firms only monitor basic trading metrics, which will do very little to help a company identify an activist lying in wait. Stock watch is more art than science. Only a handful of stock surveillance firms have their ear to the ground, read the tea leaves when reviewing a company’s daily transfer sheets and can give a company a head’s up in a case of rapid and furtive stock accumulation by an activist.

Mistake Four: Unprepared meetings with activists

“I don’t need anyone to babysit me. If I can’t handle a one-on-one with a shareholder, I have no business being the CEO of this company,” the CEO of a billion-dollar market cap company told me when explaining why he did not need to hire activism advisors.

Six months later, he was ‘retired’.

Many executives are eager to meet activists face to face – and they underestimate their adversary. The first meeting with an activist often comes as a shock: many activists are testing executives by intentionally pushing their buttons. And most activists are quite adept at this since they do this all the time (some are even trained by former CIA or FBI interrogators).

Winter 2017 | Ethical Boardroom 31

Activism & Engagement | Proxy Fights Most executives are successful businessmen who are used to people admiring and courting them. They are not used to open criticism, let alone an aggressive confrontation. The result is often disastrous.

Many executives become first defensive, then aggressive and then say things they later regret – which is exactly what the activist was looking for. The activist will use these soundbites against the company in the ‘court of public opinion’ during a live campaign.

So how do you prevent this from happening?

Preparation, preparation, preparation. We firmly believe that the proper groundwork for a meeting with an activist is like deposition prep in litigation. It is critical to take clients through a simulated meeting with an aggressive activist and equip them with responses to the most likely tough questions and statements.

The problem is that in at least half of the situations we become involved in, the company has already been talking to the activist for weeks or even months – without prior preparation. Investor relations officers often do not even recognise investors as activists. Of course, everyone knows Carl Icahn, Pershing Square and Starboard, but there are more than 200 other activists operating in the US alone and many investor relations officers do not know them.

We have seen companies set up meetings even with the likes of ValueAct, Elliot and Raging Capital without knowing they are well-known activists. Uninformed investor relations officers also allow activist investors to ask questions on earnings calls, facilitating a public take-down of management in front of all the company’s major investors and analysts. The same happens at industry conferences:

often the conference organisers are arranging for one-on-one meetings between activists and unwary companies – often with unfortunate consequences.

The take-away is that your company’s investor relations officer should run every inbound inquiry from new investors by activism specialists to identify activists in a timely manner and schedule a prep session before speaking with an activist by phone or in person.

Most executives are successful businessmen who are used to people admiring and courting them. They are not used to open criticism, let alone an aggressive confrontation. The result is often disastrous Mistake Five: No ‘break the glass’ response plan

Activist attacks rarely come out of the blue, but either way it is important to have a ‘break the glass in an emergency’ response plan.

Every company should retain a response team that includes an investment banker, special proxy fight counsel, regular outside counsel, PR firm and proxy solicitor – and designated personnel at the company. This

response team should prepare a detailed response plan and standby press releases for the most likely contingencies (e.g. plain or aggressive Schedule 13D filing, nasty public letter, or an unsolicited takeover bid).

The team should get together on a call once a quarter to update the company on any threats or trends and to review the company’s shelf poison pill, bylaws and corporate governance practices to make sure they are state-of-the-art from a proxy fight perspective.

Moreover, companies should take their board of directors through a ‘shareholder activism boot camp’, including a mock proxy contest.

In our experience, companies with a response plan in place are, in fact, less likely to ever have to ‘break the glass’ – these companies are one step ahead of the activists, making an attack much less likely.

Conclusion

We hear from many small and mid-cap companies that they are reluctant to invest time and effort into shareholder activism preparation. This never ceases to amaze me. In an era of shareholder activism, chances of an activist attack on your company are high and increasing.

If your company was not the target of an activism campaign in 2016, chances are high that you will confront one in the next year or so. It borders on malpractice not to prepare for this contingency. After all, everyone is buying homeowner’s insurance, though the likelihood of a fire is low. So why would you not insure your company against shareholder activism when the odds of being confronted by an aggressive activist are so much higher?

PREPARING A RESPONSE TEAM Companies with a plan can stay one move ahead of activists

32 Ethical Boardroom | Winter 2017

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Activism & Engagement | Activism in Germany

Turning the wheels of investment Reiner Sachs

CEO, Shareholder Value Management AG

Changing tactics will establish forward-thinking companies that deliver long-term, sustainable value for customers, employees and shareholders

While activist shareholders have been a part of the picture in the US and UK’s equity capital markets for decades, in Germany they play a rather more secondary role. This is mainly due to the understanding of the roles of the management board, supervisory board and the shareholders’ annual general meeting.

In Germany’s dual board structure, the independent, authoritative management board has never been subject to the instructions of the supervisory board in terms of business leadership.

The idea of shareholders wielding influence or sharing corporate responsibility (either inside or outside of the annual general meeting) is very much unfamiliar. Correspondingly, the press regards activist shareholders as, at best, suspicious, and rarely as benevolent – instead, they are often presented as short-term oriented or predatory. Public discussions of their concerns have rarely taken place.

Yet this picture is gradually changing.

Previously, the concept of an activist shareholder simply didn’t exist in the German corporate governance code, but there is now a 34 Ethical Boardroom | Winter 2017

suggestion under consultation to insert a new section 2.1.3: “Especially institutional investors are required to exercise their ownership rights actively and responsibly in accordance with a consistent and transparent framework of rules respecting also the concept of sustainability.” This recognises the fact that activist shareholders can indeed be a positive force for change.

The code is, therefore, following a real development; in Germany in the last few years, activist investors have been making headlines increasingly often. They have already targeted several companies - and not only DAX-listed corporations. The international trend has therefore also spread to Germany – indeed, this type of investor has been gaining ground since the turn of the millennium.

According to a study by the global management consulting firm Bain & Company, the number of activist investor deals worldwide rose on average 34 per cent a year between 2000 and 2014. Activist investors are managing around eight per cent of the capital invested in hedge funds worldwide, currently amounting to around $3billion. But beyond the large corporations, activist shareholders are setting their sights more and more on medium-sized and smaller companies. There are often sound reasons for this, since many companies don’t always work in the interests of their shareholders.

When you think of the leadership of a company, hard facts and figures are what spring to mind first and foremost: this involves the quality of the products, the market positioning of the company, sales development, profit – and, in a broader sense, the employees. It’s bad enough that these are rarely mentioned, but what is often completely missing in Germany with regard to the running of a business is how shareholders and their interests are handled.

Management boards often forget that the company belongs to the shareholders.

Keeping investors’ interests in mind

As fund managers responsible for the interests of our investors, we search first and foremost for companies who keep their shareholders in mind and who do everything they can to increase the value of the company for its owners. On the other hand, we see the opportunity to influence a company in terms of its shareholder value, i.e. in the interests of investors. We at Shareholder Value Management AG therefore use this opportunity for our mandates – as activists.

But that’s not always easy.

As well as the corporate structure outlined above, shareholders in Germany are confronted with the rather complicated www.ethicalboardroom.com

Activism in Germany | Activism & Engagement situation that a publicly traded company’s supervisory board is not just made up of that company’s owners. It is influenced by the workforce of that company and also very much by unions and other interest groups. Direct contact with the supervisory board is – unlike with the management board – often difficult for the owner. And that is a problem, since that is where the strategic decisions are made.

Activist investors on the march Regardless of this, activist investors from across the globe have, in recent times, been repeatedly attempting to influence German companies. Indeed, the hedge fund Knight Vinke from Monaco has written up a white paper addressed to the supervisory board of the energy company E.ON, pointing out how the company should be restructured. Cevian Capital has meanwhile pursued a rather more long-term strategy for its holdings in Bilfinger and ThyssenKrupp, in order to reposition the companies.

At sporting goods manufacturer Adidas, Southeastern Asset Management most likely stands behind the decision to move away from the golf sector – even though this is publicly denied by Adidas. Since its diesel scandal, the car manufacturer Volkswagen has also INVESTOR LANDSCAPE Activists are making the headlines in Germany

increasingly become the focus of activist shareholders. Indeed, London-based hedge fund The Children’s Investment (TCI) penned an open letter to the company’s top leadership, criticising the management board’s high salaries and the company’s close ties with Lower Saxony’s state government.

Second-line stocks come to the fore

As well as the large DAX-listed corporations, activist shareholders are now pursuing more and more medium and smaller-sized companies. Recent examples include the advertising group Ströer (Muddy Waters), the cable network operator Kabel Deutschland and the pharmaceutical wholesaler Celesio (Elliott Associates), the payment processing specialist Wirecard (Zatarra) and the pharmaceutical manufacturer Stada (Active Ownership Capital). www.ethicalboardroom.com

Forms of shareholder activism In the case of Stada, AOC has opened a new The form of shareholder value activism which chapter on shareholder activism in Germany.

AOC showed at Stada comes close to our Under the leadership of long-ruling CEO preconceived idea of it. For our mandates Hartmut Retzlaff, who was hardly controlled by at Shareholder Value Management AG, we a weak supervisory board, Stada in recent years pursue various approaches in the interest remained well below its commercial potential. of our investors, including, inter alia, the AOC has not limited itself to merely placing funds Frankfurter Aktienfonds für Stiftungen applications for the removal and re-election (Frankfurt Equity Funds for Foundations) and of members of the supervisory board on to Prima Globale Werte (Prima Global Assets). the agenda of the annual general meeting; Accordingly, in exceptional situations where on the contrary, AOC has, for the first time we are not able to intervene structurally, our in Germany, used the Federal Gazette’s objective is to ensure that shareholders at shareholder forum to publicly invite qualified least receive an appropriate compensation. shareholders to participate in selecting This is the case with, for example, squeezecandidates for the supervisory board. This has outs or control and profit transfer agreements. led to AOC garnering support from many of the Here we do not shy away from a judicial review larger minority shareholders. As a result, five in legal proceedings, or even a legal challenge. of the nine members of the supervisory board In other cases we have pressed for the have been replaced. The chairman of the replacement of a supervisory board and, supervisory board, Martin Abend, has been in one case, even supported a change of removed. The newly elected supervisory legal form into an SE board member Eric Cornut, (societas europaea). who was put forward What is often For the mining logistics

by AOC, now leads the company SMT Scharf we strategy committee of the completely missing agreed in a contract with supervisory body and wields in Germany with several shareholders to significant influence over the strategic orientation of regard to the running act in concert to amend the agenda of the annual the company. There has of a business is general meeting. In the how shareholders AGM we therefore won a majority to replace and their interests the supervisory board are handled. with industry experts.

At Pulsion Medical Management boards Systems, the efforts often forget: the of one shareholder led company belongs to to the company being restructured from an AG the shareholders into an SE. The reason: in an SE the management board and supervisory body can either remain on two levels, or can be combined into one. The latter option was implemented by Pulsion in order to streamline company management. In doing so, the disadvantages of the German dual been a quantum leap in the quality of the board system described above were able to be supervisory board’s composition. In the resolved. As part of this restructuring, my board course of this development, the CEO also colleague Frank Fischer moved on to the board resigned his position. of directors and could thus participate in the AOC’s initiatives at Stada, which were very positive development of the company, also actively supported by US investor Guy which also generated value for all shareholders.

Wyser-Pratte, have led to a new awareness on Influence on various levels the part of many shareholders. On the one hand, We have just begun to work together with the there has now been public discussion over the e-commerce solutions provider Intershop influence that even minority shareholders can Communications AG. Together with the exert on the development of a company. On the shareholder Beteiligungen AG we possess a 24.9 other hand, this has also led shareholders of per cent share. We see ourselves as long-term large mutual funds companies, such as the oriented investors, who can actively support the Deutsche Bank subsidiary Deutsche Asset company. For us, ‘active’ means constructively Management or the investment company Union assisting Intershop as partners. We provide Investment (part of the cooperative financial the management and supervisory boards with services sector), to concretely speak out on guidelines for positive development that will staff matters in annual general meetings and create value for shareholders, which I shall have therefore made a public impact. Stada’s discuss below. We also encourage staffing the experience seems to be just the first of many supervisory board with industry experts. further actions at other companies.

Winter 2017 | Ethical Boardroom 35

Activism & Engagement | Activism in Germany

In the tradition of Warren Buffet So, what principles and guidelines are important to actively influence a company and its management? As a new anchor shareholder, we want first of all to be a reliable partner, accompanying the company over the long term into a competitive, healthy and strong future.

In this way we see ourselves in the tradition of value investors, such as Warren Buffet, who work alongside management in implementing their long-term business commitments.

For every company, it is an absolute necessity that the customer remains paramount. Creative and motivated employees are therefore the basis for long-lasting success. But beyond this, for us there are key levers that make a company a long-term success for its shareholders, too. It cannot be forgotten that the shareholders bear the whole risk of their capital contribution.

limited potential, and must they therefore be either restructured or even sold off?

Fourth: Only keep assets that will benefit the company’s value in the long term.

Management should only concentrate on activities that will benefit the long-term increase in value of the company. This includes the research division but also entails recruiting new employees on strategic grounds. You should not continue to operate in sectors that have less potential.

Buybacks and dividends

Fifth: Efficiently allocating capital comes from weighing up alternatives when appropriating profits. Share buybacks can be

Creating sustainable value

To clarify something: many companies are focussed on short-term profits. But this means that the goal of sustainable growth, which is important for us, is often overlooked. Indeed, according to a recent survey of company leaders, an unbelievable 80 per cent of board members in Germany would cut necessary expenditure on research and development in order to achieve the desired quarterly figures.

What is the result of such an action? The possibility of creating lasting value for the company and the shareholders is lost.

Eight principles for shareholder-friendly business leadership

So what must a company do in order to grow and be successful in the future? From our point of view there are some key factors in achieving this. For us, there are eight factors, which take priority.

First: It’s important to move your focus away from short-term quarterly expectations of the market and its analysts. To present great figures in the short term, many companies neglect the development of growth drivers, which would provide a company with long term, sustainable benefits.

Second: It should be ensured that the management board and other executives are personally invested in the company. Only in this way is it guaranteed that they think and act as an owner and carry the same risks as the other shareholders.

Third: Strategic decisions must be made to optimise the future value and growth of the company, even if it means that short-term objectives and targets will not be achieved.

In practice this means that, when it comes to various strategic options, the management must always ask itself: which operational units have the greatest potential to secure growth in the future and thus raise the value of the company? Would investment therefore be necessary for this? Which units only have 36 Ethical Boardroom | Winter 2017

For every company, it is an absolute necessity that the customer remains paramount. Creative and motivated employees are therefore the basis for long-lasting success one form of profit appropriation. We see share buybacks, however, not as a way of supporting the share price, but rather to consolidate value for existing shareholders. Here, however, we do regard it as a prerequisite that the market value would be significantly lower than the fair value. Share buybacks should always be seen against a backdrop of alternative investment opportunities for free cash flow.

Also, with regard to the payment of dividends, it must be considered that a flat-rate dividend payout ratio, which remains the general rule for the time being, can by definition not be efficient. Consequently, we advise you to refrain from these. In cases of reasonable opportunities for acquisitions, you should not hesitate to consider not distributing dividends. In addition to this, we attach great

importance to the efficient management of working capital.

Sixth: Pay out surplus money as dividends to shareholders when it is not required for value-adding investments. If cash reserves are not needed for strategic investments, they should be distributed to shareholders as dividends or invested in share buyback programmes. On the other hand, we see it as an absolute necessity to maintain a continuously updated long/short list for possible mergers and acquisitions. A potential target for acquisition should, however, possess industrial logic and above all be affordable! The idea of ‘buy and build’ – i.e. buying in order to grow – must remain at the forefront. Often it is the takeovers of smaller, technology-driven companies that generate value.

Seventh: Board members, senior executives and leaders of operational units should be rewarded for generating consistently superior returns. Incentives that have a long-term effect must therefore be created. These figures do not just stand alone – they also set the share price in relation to the peer group. Indicators such as return on equity (ROE), the net operating income, free cash flow, EBIT to free cash flow conversion, and the return on capital employed (ROCE) are useful key performance indicators for evaluating performance. If these KPIs are positive, then management deserves a higher bonus. At the same time, if set targets are not achieved, then bonuses can also be taken away. Furthermore, management must make sure that employees can continue to develop. Top people must be given appropriate challenges and encouragement.

And last but not least, eighth: Regularly and reliably provide investors with figures concerning the value development of the company. Therefore we see it as efficient and opportune to organise a separate annual meeting for investors, analysts and media, separate from the annual general meeting.

This takes place ideally at the company’s head office. This ‘capital markets day’ should provide open and transparent information about the progress of business and the current situation of the company, as well as targets and target attainment.

With our concept of shareholder value we help to establish strong, future-orientated companies that create long-term, sustainable value for customers, employees and shareholders. We will continue to recommend these principles and guidelines to the management and supervisory boards of our investments and, with this in mind, we will achieve good results for shareholders and therefore our investors. It is clear that shareholder activism is a useful and very effective instrument for implementing good corporate governance – which ultimately is the role of an active and responsible owner.

This is a trend that fortunately is now becoming ever more prevalent in Germany. www.ethicalboardroom.com

Activism & Engagement | Investors

Jean-Nicolas Caprasse and Julia Wittenburg

Jean-Nicolas, Managing Partner, and Julia, Principal, CamberView Partners Europe

Keeping on the

front foot

How European companies can successfully manage their investor engagement process The post-financial crisis era has seen the emergence of institutional investors taking a more active ownership role vis-à-vis their portfolio companies and assuming a more engaged risk oversight function as they discharge their fiduciary obligations.

Against a background of increasing pressure on investors to behave as ‘responsible owners’, shareholders have become more assertive in their communications and interactions with executives and non-executive board members of their portfolio companies, an evolution that remains in full swing across capital markets.

Increased fiduciary responsibility of institutional investors In Europe, the increased debate about corporate governance and the responsibility of institutional investors to oversee non-financial risk factors has led to the creation of stewardship codes or guiding principles in several markets, including the UK, the Netherlands, Switzerland and Italy.

The Principles for Responsible Investment (PRI) – the international initiative seeking investor commitment to a proper understanding of investment implications of environmental, social and governance issues and the integration of these issues into investment and ownership decisions – has also gained considerable visibility. It now has nearly 1,400 members and a combined $59trillion of assets under management.

The list of various initiatives in this space has proliferated, both at national and international levels and at political and NGO levels. The ongoing debate around sustainability and climate change, only enhanced by the recent climate agreement decided on at the 2015 Paris Climate Conference (COP21), is pushing 38 Ethical Boardroom | Winter 2017

investors to take a more active role in understanding how their investee companies are managing environmental and social risk factors and how their businesses are responding to increasing regulation in this field.

As asset managers acting on behalf of underlying clients are increasingly exercising their stewardship responsibilities and overseeing risk areas that have Demands on historically been left unattended, investors to act as it is becoming vital that companies structure a successful shareholder responsible, longengagement programme. Whereas term owners have in the past investors would sell out of their investments when increasingly led to faced with an underperforming engagement investment or unresponsive activities between management team, demands on investors to act as responsible, investors and listed long-term owners have increasingly companies that seek led to engagement activities between investors and listed companies. to hold management of traditional Investors increasingly are accountable ownership structures seeking to hold management dominated by bank and accountable in areas including insurance companies on the share registers operational performance, strategy execution, of many continental European companies has executive pay, as well as board oversight and led to an increase in their free float, thereby environmental management. The emergence increasing companies’ needs to stay focussed of these new and influential investors, on their investors’ needs. The 2008 EU including passive asset managers and Shareholder Rights Directive further smoothed activists, has added an extra layer of out the voting mechanics across many complexity to the widening array of topics in European markets through the introduction which investors are seeking to engage with of record dates and the removal of traditional company managers and board members alike. blocking of shares prior to shareholder Foreign ownership meetings, leading to an increase in quorum. on the rise in Europe In addition, the upcoming Draft In Europe, foreign ownership of EU-listed Shareholder Rights Directive is likely to companies (including ownership by investors further push European investors to increase based in EU countries other than the country their vote participation by reinforcing of domicile) has been trending upward their fiduciary duty to vote and engage for the past three decades, while the share with investee companies. of European investors in cross-border Index-tracking funds investments has been declining. The One of the most significant developments emergence of large US and UK institutional in the investor landscape has been the investors and the gradual dismantling www.ethicalboardroom.com

Investors | Activism & Engagement This has brought about an increase in investor-led activism in areas such as executive pay, board composition and diversity and other governance topics.

On the opposite side of the spectrum is the rising presence of activist investors. Activist hedge funds in particular – many of which are event-driven and of US origin – have been targeting European companies. They aim at unlocking shareholder value through governance improvements, refocussing strategy or changing capital allocation policy.

Recent figures indicate a rise in the number of European activist fund launches as well, such as Active Ownership Capital in Germany that led to the ousting of the chairman of the supervisory board of a pharmaceutical company in August. Activist tactics largely remain the same regardless of nationality, but activists have become increasingly adept at using sophisticated techniques to adjust to local market mechanics and legislation.

A prominent example is Elliott Advisors, the London-based international arm of New York-based activist hedge fund Elliott Management, which has built up stakes in acquisition targets across Europe, extracting higher bid premiums by leveraging local merger regulation.

While activist investors vary by strategy and investment horizon, they often look to influence companies directly by seeking board representation. Specialist research demonstrates that the number of European proxy fights has remained persistent at around 20 per year, but the size of the target companies has increased in market cap over time, peaking at a median of €231million in 2016, mirroring the trend in the US where activists have not shied away from targeting Fortune 100 companies in recent years. According to the specialist publication Activist Insight, in Europe the total number of companies publicly targeted has increased from 51 in 2014 to 67 in 2015 and a surprising surge to 64 for the first half of 2016.1

POWER BROKERS Index investors have the ability to influence shareholder meetings

emergence of index-tracking investment funds. Statistics indicate that actively managed funds are underperforming index funds over time while charging higher fees than their passive counterparts.

Passive powerhouses Vanguard, BlackRock and Legal & General are among the investors who have amassed considerable assets under management at a global level.

According to the Wall Street Journal, in the US, Vanguard’s nearly $470billion Total Stock Market Index Fund is now nearing the AUM of the four largest active funds in the US combined.

Index-traded funds, by their very definition, are long-term investors, with little manoeuvring room to sell out of their investment. To influence a company’s management over time, these asset managers have set up governance and stewardship teams responsible for exercising ownership responsibilities both through voting rights and engagement with management and boards. Combined with their considerable www.ethicalboardroom.com

holdings size, their more active role means that index investors have the ability to significantly influence outcomes at both routine and contested shareholder meetings.

INCREASING US/UK SHAREHOLDER BASE AT EUROPEAN COMPANIES OVER TIME (2005-2015) Ownership evolution by market (%): DAX 30, FTSE 100, CAC 40 DAX 30 FTSE CAC 40 45%

44%

41%

38%

37%

35%

41%

43%

31%

45%

40%

28% 27%

26%

12%

15%

31% 44%

38%

24% 21% 16% 7% 4%

5%

20% 7%

16%

32%

30% 17%

17% 7% 4%

4%

7%

2005 2010 2015 2005 2010 2015 2005 2010 2015 n Other n EU Core Member States n United States of America n United Kingdom

Winter 2017 | Ethical Boardroom 39

Activism & Engagement | Investors An activist will often use governance shortcomings and operational weaknesses to obtain support from other institutional investors in a proxy contest or activism situation. It is worth noting that large institutional investorsâ&#x20AC;&#x2122; willingness to side with activist managers, particularly when their own engagements have failed to produce the desired results, is often the tipping point in an activism situation.

At the same time, in the US, there has been a significant rise in settlement of proxy contests prior to reaching a shareholder vote. The debate is now shifting, with various long-term investors, including BlackRock and State Street, issuing warnings to corporate boards not to settle with activists too rapidly in order to preserve long-term value creation.

DRIVING THE AGENDA Being direct with investors will demonstrate accountability

How companies can develop an engagement programme with their investors

In this context it is paramount for companies to have a proper understanding of their investor base, as well as any substantial shifts in the type and size of shareholdings over time. Companies with a secondary listing in the US may already be in the habit of regularly verifying whether their shareholder base is composed of less than 50 per cent of US shareholders in order to be eligible for exemptions under the Foreign Private Issuer status. But most European companies will benefit from regularly conducting a shareholder identification programme in order to gain insights into the shifting investment priorities of their institutional investors.

Understanding the relevant investor teams charged with the voting and engagement process and knowing where responsibilities lie within the teams themselves are equally important factors to consider when structuring an effective engagement programme. Companies often make the error of leaving important discussions with vote decision makers until shortly before the shareholder meeting, rather than building relationships with key investors throughout the year. The internal set-up of the vote decision-making process will vary depending on the investor, so it is critical that companies understand the specific decision-making process of each shareholder. In some instances it will require companies hold separate discussions with both the investment and governance teams and also manage situations where the two investor teams do not necessarily communicate with each other.

Understanding the various stakeholders that provide input into the vote decision-making process will ensure that companies are thoroughly preparing their shareholder engagement strategy. Globally, leading proxy advisors Institutional Shareholder Services (ISS) and GlassLewis, in addition to various local players, issue research reports and advise their investor clients on how to vote at the 40 Ethical Boardroom | Winter 2017

In the last two decades, corporate scandals and ensuing legislative, regulatory and market developments in Europe, pushed investors into taking a more active ownership role shareholder meetings of the companies in which they invest. The extent to which investors follow these recommendations varies by investor, market and topic. Though it can be helpful for companies to engage with proxy advisors directly, it is necessary to understand the role these companies play in investorsâ&#x20AC;&#x2122; internal decision-making process. Specialist data providers, such as MSCI-ESG or Sustainalytics, sell-side research reports and the financial press more generally are among the various other sources that supplement investorsâ&#x20AC;&#x2122; in-house research processes.

Keeping in mind that the primary source of information that investors use remains publicly available company disclosures, it is crucial that issuers are thoughtful in their messaging to their investors.

Accompanying public disclosure and messaging concerns is the comply-or-explain environment that applies to corporate governance frameworks in most European markets. With dissent rates at European shareholder meetings on the rise, investors are demonstrating impatience with companies that have historically entrenched management who fail to address actual or

perceived oversight shortcomings, or who fail to deliver financial results for investors over time. A case in point is the executive pay debate, where votes cast against remuneration proposals have been steadily increasing and political pressure on investors has added another layer of complexity to the discussion.

Companies will benefit from driving the meeting agenda and proactively addressing matters of interest with their shareholders (strategy execution, management incentives and sustainability, to name a few).

Investors meet with hundreds of company representatives every year, so being direct and following up will demonstrate accountability, as will bringing the in-house subject matter expert and, in some cases, a board member to investor meetings. In the last two decades, corporate scandals and ensuing legislative, regulatory and market developments in Europe, have pushed investors into taking a more active ownership role. During the same time, the investor landscape has evolved in Europe with the emergence of a variety of institutional investors, an internationalisation of the shareholder base and the undoing of traditional ownership structures. Building a shareholder engagement programme and maintaining an active dialogue with investors and their relevant teams benefits companies in the long-term, especially when facing an important vote, corporate action or sensitive governance questions. To succeed with shareholders, companies must take ownership of the engagement process and remain on their front foot with their investors.

Activist Investing in Europe: A Special Report, Activist Insight, September 2016

1

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Partner +44.20.7065.6020 pdunbar@velaw.com

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CHRIS SCHMITT

MICHAEL SWIDLER

Partner +1.713.758.4458 sgill@velaw.com

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Partner +1.212.237.0020 mswidler@velaw.com

Vinson & Elkins LLP Attorneys at Law Austin Beijing Dallas Dubai Hong Kong Houston London Moscow New York Palo Alto Richmond Riyadh San Francisco Tokyo Washington

velaw.com

Activism & Engagement | Shareholders

Tom Johnson

Chief Executive Officer, Abernathy MacGregor

Shareholder engagement: An evolving landscape The best defence is a strong offence â&#x20AC;&#x201D; preparing for and engaging constructively with activists is the route to corporate success

TALK TO THE RIGHT INVESTORS Establish early who it is best to communicate with 42 Ethical Boardroom | Winter 2017

www.ethicalboardroom.com

Shareholders | Activism & Engagement

The significant rise of activism over the last decade has sharpened the focus on shareholder engagement in boardrooms and executive suites across the US. Once considered a perfunctory exercise, designed to simply answer routine questions on performance or, occasionally, drum up support for a corporate initiative, shareholder engagement has become a strategic imperative for astute executives and board members who are no longer willing to wait until the annual meeting to learn that their shareholders may not support change of some sort, or their strategic direction overall.

When active shareholder engagement works, it leads to a productive dialogue with the voters – the governance departments established by the big institutional firms, which typically oversee proxy voting. It is important to remember the reality of public company ownership. The vast majority of public companies have shareholder bases dominated by a diverse set of large, institutional funds. Engagement with these voters not only helps head off potential problems and activists down the road, but it also gives management valuable insight into how patient and supportive their shareholder base is willing to be as they implement strategies designed to generate long-term growth. Indeed, the rising level of engagement is a positive trend that could, over time, help mitigate the threat of activism if properly managed.

This all sounds encouraging in theory and, in some cases, it works in practice as well. But the simple fact remains that this kind of dialogue is unobtainable for the vast majority of public companies, despite the best of intentions on both sides.

Struggles with engagement

Even the largest institutional investors, many of whom are voting well in excess of 10,000 proxies a year, have at most 25-30 people in their governance departments able to engage directly with companies. Those teams do yeoman’s work to meet demands, taking several hundred and in some cases well more than 1,000 meetings with company executives or board members a year. But with more issues on corporate ballots than ever before that need to be researched and analysed, companies are finding it increasingly hard to get an audience with proxy voters even when a determination is made to more proactively engage. This can be true for even large companies with market capitalisations in the billions.

Indeed, for small-cap companies, the idea is almost always a non-starter, though there are workarounds. Some institutional funds www.ethicalboardroom.com

are willing to use roundtable discussions with several issuers at once to cover macro topics. Most mid-cap companies are out of luck as well, unless they are able to make a compelling case around a particular issue that catches a governance committee’s eye (more on that in a minute). Large-cap companies certainly meet the size threshold, but even they need to be smart in making the request. The net result is a conundrum at companies that are willing to engage but find their institutional investors less willing to do so, or are stretched too thin to make it happen.

The problem is a difficult one to solve.

In today’s environment, companies cannot wait for a pressing issue to engage with their shareholders. By the time the issue becomes public because an activist has shown up or some other concern has emerged that affects the stock, it is often too late to have a productive conversation. Investors in those situations must decide what they know or can learn in a condensed period; they have little ability to become invested in the long-term thinking behind, for instance, a

In today’s environment, companies cannot wait for a pressing issue to engage with their shareholders. By the time the issue becomes public because an activist has shown up or some other concern has emerged that affects the stock, it is often too late to have a productive conversation company’s change to executive pay or corporate governance. At the same time, institutional investors, while very open to and, in many cases, strong advocates for meeting with executives, cannot always handle the number of requests they receive, particularly when the requests come in during a condensed period. This has led some investors to establish requirements around which companies ‘qualify’ for a meeting, leaving some executives that don’t meet the thresholds frustrated that they can’t get an audience. Both sides are striving to improve the process in this rapidly evolving dynamic. The fact is that both sides have a lot of room for improvement.

Here are a few guidelines we advise companies to use when deciding how or even if they should more proactively engage with their largest investors.

1

If a meeting is unlikely, make your case in other ways Just because you can’t get a meeting does not mean you can’t effectively influence how your investors vote on an issue. Most

companies today fall well short in communicating effectively with the megaphones they do control – namely, the financial reports that are distributed to all shareholders. When a governance committee sits down to review an issue, the first thing it does is pull out the proxy. Yet most companies bury the most compelling arguments under mountains of legalese or financial jargon that is off-message or confusing. In today’s modern era, proxies need to tell an easily digestible story from start to finish. They need to be short, compelling and to the point.

Figure out the three to four things you need your investors to understand and put it right up front in the proxy in clear, compelling language. Be concise and to the point. Remove unnecessary background and encourage questions. Add clear graphic elements to illustrate the most important points. And be sure not to contradict yourself with a myriad of financial charts and footnotes, or provide inconsistent information with what you’ve said before. The proxy statement is the most powerful disclosure tool companies have, yet most are produced by disparate committees, piecing the behemoth filing together with little recognition of the overall document coming to life. when to make contact 2 Know Most large, institutional shareholders

and even some mid-sized ones, are open to meeting with management and/or board members under certain circumstances, but timing is key. Go see your investors on a ‘clear day’ when a meaningful discussion on results and strategy can be had without the overhang of activist demands. For most companies, this means making contact during the summer and fall months after their annual meeting and when the filing window opens for the next year’s proxy.

Institutional investors do lots of meetings during proxy season as well, but those tend to focus on whatever issues have emerged in the proxy, or even worse, whatever demands an activist is making. If you believe you are vulnerable to an activist position, address that concern before it becomes an issue with the right combination of people who will ultimately vote the shares. who to talk to 3 Know The hardest part of this equation

for most companies is figuring out who the right person is at the funds for these conversations. Is it the portfolio manager (PM) who follows the company daily and typically has the most robust relationship with the company’s investor relations department?

Is it the governance department that may have more sway over voting the shares?

The answer is likely some combination of both. Each institution has its own process for making proxy voting decisions.

Winter 2017 | Ethical Boardroom 43

Activism & Engagement | Shareholders In many cases, it involves input from the portfolio manager, internal analyst and the governance department, as well as perhaps some influence from proxy advisory firms, such as ISS or Glass Lewis. But the ultimate decision-maker is always somewhere in that mix. The trick is to find out where. Start with the contacts you know best, but don’t settle for one relationship. If you don’t know your portfolio manager and governance analyst, then you are not going to get a complete picture on where you stand. In many cases, the PM can be a helpful advocate in having a governance analyst understand why certain results or decisions make sense. Once you find the right mix of people, selling the story will be much easier. assume passive 4 Don’t investors are passive

Today, many so-called passive investors are anything but. One passive investor told me his firm held more than 200 meetings with corporations last year.

A governance head at another institution said there is little difference today in how the firm evaluated proxy questions between its active and passive holdings. You may not always get an audience, but on important matters, treat your passive investors like anyone else. You may be surprised at how active they are. These firms also tend to be the busiest, so be assertive and creative in building a relationship. The front door may not be the only option. the best messenger 5 Choose There is an interesting debate going on in

the governance community right now about how involved CEOs and board members

should be in shareholder discussions. As a rule, we view it this way: routine conversations around results and performance can be handled by investor relations (IR). More sophisticated financial questions get elevated to CFOs. Once the conversations delve into strategy and growth plans, CEOs should be involved, but usually only with the largest current or potential shareholders. And, finally, when it comes to matters of governance policy, consider having a board member involved.

Board engagement with shareholders is a relatively new trend, but an important one.

Investors are often reassured when they see and hear from an engaged board and many will confess that those meetings can change their thinking. But having the right board member who can handle those conversations and be credible is key. A former CEO, who is used to shareholder interactions, or a savvy lead independent director can fit the bill.

But with investors increasingly asking for – and indeed many boards starting to offer – meetings with directors, every board should be evaluating who that representative will be if the opportunity comes along. prepared and walk in 6 Be with a clear set of goals

Too often, companies spend too much time just trying to determine what not to say in meetings with investors and not nearly enough time working on what they want to communicate. This mistake leads to frustration and missed opportunities, not to mention a reduced likelihood that it can get an audience again.

Every investor meeting is an opportunity to better refine or explain your corporate growth

story. Walk into every meeting with clear goals in mind. Better yet, get the investor to articulate their own agenda as well. Know exactly what each of you wants to get out of the meeting and then get down to business. Be upfront and honest about why you are requesting the meeting. Governance investors are far more engaged when companies walk in with stated goals in mind. Surface potential problems and your solution to them, before they emerge.

Making the effort

Even with this level of planning, large companies can still find their requests for engagement on governance topics unheeded.

Many of the large, institutional investors have installed various thresholds, generally predicated to a company’s size, that companies need to meet to receive an audience. But that does not mean companies should give up. Continue to work the contacts you do have within each institution. Tell your best story in routine discussions, such as earnings calls or conference presentations. Those are too often missed opportunities. Look for other opportunities to get in front of investors.

Conferences can be great forums, as can organisations, such as the Society of Corporate Governance, Council for Institutional Investors or National Association of Corporate Directors. Every time you communicate externally, it is a chance to tell your story and make the right disclosures.

History is littered with companies that waited too long to do so, came under attack and lost control of their own destiny. Don’t waste any opportunity to make your best case to whomever is listening.

SEIZE THE MOMENT Investor meetings are ideal for outlining your corporate growth story

44 Ethical Boardroom | Winter 2017

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Giving Shareholders a Voice.

Protecting the Shareholder Franchise.

Jonathan Feigelson joins leading shareholder rights firm Bernstein Litowitz Berger & Grossmann as Director of Corporate Governance.

Mr. Feigelson brings nearly a quarter century of legal, financial, and corporate leadership experience to BLB&G, becoming an integral member of one of the top shareholder rights law firms worldwide.

Mr. Feigelson currently serves as General Counsel & CCO at the fintech firm Artivest. Prior to that he was TIAA’s General Counsel, Director of Corporate Governance, head of Regulatory Affairs and Senior Managing Director. Prior to joining TIAA in 2006, he was the Managing Director and General Counsel for ABN AMRO’s North American Investment Bank, and was also previously Vice President and Global Director of Equity Derivatives Compliance for Goldman Sachs. Mr. Feigelson began his career as an Assistant District Attorney in the Manhattan District Attorney’s office in the Financial Frauds Bureau specializing in securities and bank fraud cases.

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Global News Asia & Australasia

Singapore plans Companies Act amendments Proposed changes to Singapore’s Companies Act would boost the country’s “ongoing efforts to maintain high corporate governance standards” and its “strong reputation as a trusted and clean financial hub”, according to Singapore’s Ministry of Finance and Accounting and Corporate Regulatory Authority.

Under the draft new rules, Singapore companies will need to hold annual general meetings within a set timeframe, while limited liability companies and foreign companies will be required to maintain lists of beneficial owners.

Changes to the Companies Act also aim to reduce regulation while enhancing transparency.

The Institute of Directors (IoD) has urged companies listed on the New Zealand stock exchange (NZX) to set gender diversity targets to improve “concerning” gender statistics.

Seventeen per cent of NZX board members were women in 2016 — a figure unchanged from 2015.

The IoD, which offers a number of programmes and initiatives to “help boards ensure diversity is about attracting and retaining diverse talent in governance”, has called on companies to ensure 30 to 50 per cent of board members are female.

Felicity Caird, IoD manager at the governance leadership centre, says: “The dividend that diversity pays is bringing different perspectives and more robust decision-making, effective risk management and better company performance.”

James Packer returns to Crown Resorts boardroom Australian billionaire James Packer will make a return to the board of entertainment company Crown Resorts in February, just over a year since he resigned.

Crown Resorts chairman Robert Rankin has stepped down from the board as part of a reshuffle of the company’s senior leadership and is replaced by current deputy chairman, John Alexander.

The board shake-up follows a steep decline in profits.

In 2016, 18 employees of the gambling group were arrested in China for suspected ‘gambling crimes’.

According to Packer, Crown Resorts is to put an increased focus on its core Australian business.

SEBI calls for more transparency from Indian boards

Samsung heir in corruption probe South Korea has sought an arrest warrant for Samsung heir apparent Lee Jae-yong (above), accused of bribery, embezzlement and perjury.

Mr Lee is accused of instructing Samsung subsidiaries to make payments totalling $36million to the family of Choi Soon-sil, a friend of the country’s impeached president, Park Geun-hye, in return for business favours.

Lee became the de facto head of the Samsung Group after his father, Lee Kun-hee, suffered a heart attack in 2014 and has pledged to make changes to ensure that Samsung’s corporate governance meets international standards.

46 Ethical Boardroom | Winter 2017

New Zealand lags behind on gender diversity

Capital market regulator Securities and Exchange Board of India (SEBI) has called for greater corporate governance in Indian firms to protect the interests of all stakeholders.

The International Advisory Board (IAB) of SEBI has proposed increased transparency in the processes for the appointment and removal of board directors and said that companies should have better systems for evaluating the performance of directors.

At a meeting in January, IAB said: “It has to be realised that good corporate governance is about helping the company achieve its objectives, implement its corporate strategy, while keeping the interest of various stakeholders in mind.”

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Asia & Australasia | Japan

Corporate governance in Japan now Nicholas Benes

Representative Director, The Board Director Training Institute of Japan

Much progress has been made in the 18 months since the introduction of the Japanese corporate governance code, but there is still a lot to be fixed It is now a year and half since Japanese companies started to ‘comply or explain’ with Japan’s first corporate governance code – a milestone, which was reached less than 18 months after I formally proposed the code to the ruling party’s growth strategy committee. Moreover, additional reforms are on the way.

On the one hand, this rapid progression reflects the continuing clear commitment of the government to reforming corporate governance in Japan in order to increase profitability at Japanese companies. On the other hand, in practice companies and investors alike are having trouble keeping up with the pace of the recent reforms. As the Asian Corporate Governance Association and CLSA so aptly wrote, now ‘the hard work begins’.

48 Ethical Boardroom | Winter 2017

‘Best practice’ is fortifying its beachhead

The good news is that Japan’s corporate governance code set a base that can be improved upon and has given a firm foothold to the aspirational concept of ‘best practices’ in Japan.

This by itself is historic, especially when you consider that some of the practices were totally new here. For instance, after I proposed the concept to the Financial Services Agency, a Japanese word had to be invented for ‘lead independent director’.

Similarly, at the time, few here would have understood what was meant by ‘executive sessions’ or ‘board evaluation’.

Major, measurable steps forward Today, Japan has made significant progress: About 80 per cent of companies listed on the first level of the Tokyo Stock Exchange (TSE1) now have two or more independent directors (INEDs) on their boards, according to ascertainable criteria for ‘independence’.

JAPAN’S CORPORATE GOVERNANCE CODE: EXAMPLE PROVISIONS Multiple non-executive directors (encouraged: ‘one-third’ of board) Principle to ‘fully utilise’ their independence and ‘objectivity’ Principle of separation of management functions from oversight functions Succession planning and evaluation of executives Principles regarding prudent risk-taking, capital allocation, sustainability Encouragement of committees, ‘executive sessions’, lead independent director Disclosure of policies on director training, board self-evaluation, nominations Disclosure or the ‘reason’ and logic for cross-shareholdings Disclosure of arrangements for engagement with shareholders Encouragement on board diversity and appointment of female directors www.ethicalboardroom.com

Japan | Asia & Australasia This is almost four times the percentage recorded only two years ago. At almost 23 per cent of TSE1-listed firms, INEDs make up one-third or more of the board.

Approximately 40 per cent of TSE1 companies now have a voluntary ‘nominations committee’ of some form, a level which is eight times as high as it was 2014. Voluntary compensation committees are also increasing in number.

About one-fourth of TSE-1 companies claim to fully comply with the code and 90 per cent have implemented at least 90 per cent of its 73 provisions. There is now vastly more disclosed information about actual governance practices and policies at each company. This is because the code not only requires ‘comply or explain’ statements, but also (irrespective of that) disclosure about each company’s policy on 11 different topics. Even when such disclosure is shoddy, at least one can confirm that those companies lack rigor and substance. Investors now have so much to shoot darts at that my organisation has constructed a special search engine.

About 40 per cent of TSE1 companies have some form of voluntary ‘corporate governance guidelines’, although that is not required by the code. Even if many of them need more detail, this self-disciplining concept has taken hold.

(I proposed it to Japan’s Financial Services Agency for the code, but to no avail; but the Board Director Training Institute gave several free seminars explaining why ‘policies’ have to actually exist in order to be ‘disclosed’.)

Most Japanese companies are more open to engagement by investors than before, a trend that is supported by the stewardship code. The ecosystem is improving.

A matter of national policy

A potential virtuous circle is taking root.

Better governance is now recognised as a core national policy – something that is essential for Japan’s future. There is increasing scrutiny from the media and the public. At the same time, votes against the re-election of CEOs at firms with low return on equity or governance mishaps are increasing.

In Japan’s shame-based society, where executives hate to be in the news unless it is about something positive, these are powerful forces. For instance, the nine companies in the TOPIX 500 where the CEO’s re-election was approved by less than 80 per cent in 2015, found a way to improve their return on equity by an average of 2.4 per cent in 2016 (when fully 26 firms received less than an 80 per cent vote for CEO re-election). Investors are starting to vote for results and companies are starting to react.

In Japan, the expression ‘making a statue of Buddha without instilling his spirit’ is used to stress the importance of sincere dedication to substance rather than just going through the motions. The expression fits in this case.

The reforms were put in place so fast that companies need more time to understand what the principles of the code require in terms of detailed practices and mindset. At the same time, investors also need to learn how to leverage the code’s principles, by considering with experts how its principles can be reflected in granular procedures in the context of Japanese law and telling companies exactly what they expect.

There’s actually a lot to mine in the code.

‘Putting the spirit in the Buddha’ Simply put, a lot of learning and practice refinement needs to take place, on both sides of the investment equation. That is the reason why my own organisation, which focusses on

A potential virtuous circle is taking root. Better governance is now recognised as core national policy — something that is essential for Japan’s future governance-related training, is becoming much becoming busier. But in my own view, given where Japan has come from and the number of listed companies, we are not nearly busy enough!

The diagram below describes what is going on within many Japanese companies. As expected, there are a small number of true ‘leaders’ and a lot of relative ‘laggards’. The former are setting examples for the latter to follow. Organisational change at the ‘substance’ level takes time and at a good number of companies, internal discussion, training and practice enhancements are still moving forward. But at too many other firms, the internal discussion and improvement process slowed to a near stop after the rush of the first

www.ethicalboardroom.com

The challenges that lie ahead What slows down governance and practice improvement the most? Far and away, the following are the bottlenecks that investors need to focus:

Most nominations committees are cosmetic Although they are growing in number, most ‘advisory HR & nominations’ committees are cosmetic in nature. Half of them only meet twice a year, even though (or rather, precisely because) nominations is the political football from which the CEO derives his power. The CEO himself usually sits on the committee, thereby eviscerating its independence and preventing it from evaluating him objectively. In some cases, the CEO is not even a valid subject of the committee’s consideration. (The situation for ‘compensation committees’ is similar.)

WHAT’S GOING ON BEHIND THE SCENES? INVESTOR VOICES ON SPECIFICS ARE NEEDED ‘COMPLY’ (% of principles) 90%

Still a work in progress But inside corporate boardrooms there is still a lot to fix. Unless both the government and investors take further steps, I fear that rigorous commitment to true practice ‘substance’ will be elusive and the reforms may lose their momentum.

year, in the absence of specific practice improvements requested in detail and on paper by investors. In other words, ‘we must have done enough, since no one is complaining much’.

Companies need clear guidance and to see a hint of a stick. This means that investors need to prioritise key sections of the code, suggest detailed practices and criteria focussing on them, set forth a polite warning that proxy voting will reflect the results and then (after a year or so) vote against the re-election of senior executives who do not respond sufficiently.

This is not to say that all companies will resist meaningful change unless absolutely forced. Refining practices that do not exist at most firms yet would take time even without resistance. One also has to understand that to some extent, Japan’s governance code is inevitably vague in certain key areas – it is far less ‘prescriptive’ than the UK code – because it had to cope with three different corporate legal frameworks for board governance. It will take time for investors and companies to reach consensus about the unstated details. Reflecting those lessons learned will be the task of the revision of the code, which will probably occur in 2018.

80%

<10% –Committed <60-70% CEO, rigour, many global – ‘Let’s say we comply’ investors, or in – Senior executives did not clearly financial industry message early on that CG has high priority, but care about ‘how we look’.

Dedicated managers often exist, but DISCUSSION UNDERWAY ran up against: “which investors, ‘Let’s see what minimum specifically, are asking we can get away with?’ for that?” vs ‘Let’s keep thinking about how to implement?’ <20% – Domestic industry, few global <5% investors, few internal – Confident it will champions not matter ‘EXPLAIN’

Winter 2017 | Ethical Boardroom 49

Asia & Australasia | Japan The fact that many companies have formed such committees even though they are only mentioned as a voluntary practice by the code is progress. But now it is time for investors to: a) shame the companies that do not have them, while b) requiring all members to be independent and for the committees to use forward-looking needs matrices that reflect strategic needs, rather than seniority, loyalty to the CEO, or congeniality driven by the desire to be re-nominated.

Executive and director training polices below ‘developed nation’ quality The two most common responses we receive in surveys after our intensive director training courses are: ‘now I understand what my role as a director is!’ and ‘I learned how little I know about finance and reading financial statements.’ (I am not making this up.)

Based on that average reality, in ‘educationobsessed Japan’, you would think that executive skill-building and director training would be no-brainers – especially since the code itself requires director training both before election and on a continuing basis. Yet far too many of the companies who say they ‘comply’ with this principle of the code, say they do so not by actually training anyone, but by ‘explaining board resolutions to outside directors before board meetings’, ‘giving tours of our facilities and teaching outside directors about our strategy’, or (in better companies) ‘offering directors the [unutilised] opportunity to receive training if needed’. And it is almost never clear who is accountable for the so-called ‘policy’, so briefly described.

Shareholders need to call their bluff.

In a country where 80 per cent of directors are ‘promoted’

Japan is a global outlier in that its executives are ‘undercompensated and under-performing.’

They do not take enough entrepreneurial risk internally, sending director candidates to an external training programme in advance of asking shareholders to vote for them only requires senior management to order that it is done. Since almost none of those candidates have prior board experience when first appointed, that is the least the company can do if it is asking investors to elect them.

Clearly, this ‘80 per cent of directors’ is the group that controls the board – not the independent directors. Yet global proxy advisors follow domestic practice by automatically approving almost all new internal candidates with no screening criteria whatever. Investors deserve far better than this.

Compensation plans need better design, more details disclosed Most Japanese companies do not have standardised global HR systems for talent mapping and executive evaluation. This problem simply continues at the board level.

Executive evaluations are surprisingly subjective in nature and the major portion of compensation is fixed cash salary which rises in lockstep fashion based on one’s seniority (years of service.)

Japan is a global outlier in that its executives are ‘undercompensated and under-performing.’

They do not take enough entrepreneurial risk. In this context, the good news is that performance-based compensation plans now exist at many companies and the concept is being promoted by the government. Indeed, stock compensation plans are now in place at most TOPIX 500 companies. However, in most cases: a) their design is rudimentary and their magnitude small; b) details of about targets, metrics and calculation formulas are not disclosed; and c) clawbacks are non-existent. (In fact, director contracts are almost non-existent!)

Stay tuned

The government is moving forward on several fronts where I have made detailed proposals.

Together with the corporate governance consultancy ISS, it is questioning the custom of appointing retired directors to cushy ‘advisory’ positions. It is moving to amend regulations so as to encourage corporate pensions to sign the stewardship code, inasmuch as only one non-financial pension plan has done so. And it is focussing on the need for more effective nominations committees.

If shareholders ask for the right specifics, good Japanese companies will now be in listening mode. How can you tell a ‘good’ company from one of lesser quality? It is one that trains its executives about governance and finance before asking shareholders to vote for them.

JAPAN’S HIGH ASPIRATIONS There has been significant progress in corporate governance 50 Ethical Boardroom | Winter 2017

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Technology | Information Governance

Jason R. Baron

Of Counsel at Drinker, Biddle & Reath LLP and Co-chair of the Information Governance Initiative

Information governance oversight: Questions for board members to ask Good IG isn’t just about protecting an organisation from data breach. Information challenges are many and various – and someone needs to own responsibility for them What keeps you up at night?

Increasingly, the answer for board members and CEOs is the risk of a cyber breach. A variation on an online meme that has gone viral more than adequately sums up this concern: “There are only two kinds of companies: those that have been hacked and those that will be.”

Accordingly, in the governance space we have recently seen emerge a variety of calls for boards of directors to be asking questions of their CEOs, CISOs and CIOs about how companies are preparing for breaches and how they will deal with their aftermath through agreed protocols.

But while factoring in cyber risk is an increasingly real part of the corporate world, arguably there is an even more fundamental material weakness across the enterprise that boards of directors should be addressing: the company’s lack of a clear information governance strategy or framework for decision-making.

Information governance (IG) has been defined as “the activities and technologies that organisations employ to maximise the value of their information while minimising risks and costs”.1 Of course, a part of the overall risk posed by data is the possibility of cyber breach. But there is much more to information governance than simply addressing one’s security concerns. At bottom, there are the questions of why and 52 Ethical Boardroom | Winter 2017

how data has been left to accumulate in the first place and what policies are in place to manage and control its continued growth.

Indeed, there are a host of overlapping issues surrounding not only security and preservation of data but also touching on data sensitivities and privacy, access to data in litigation and investigations, regulatory compliance and, increasingly, performing analytics for the purpose of monetising corporate data assets. Various facets of IG are displayed in the ‘pinwheel’ (see Figure 1, page 54). Board focus on cyber breach issues alone is a start, but, high-level attention should be paid to a much broader range of technical and policy issues touching on all aspects of the overall corporate data environment.

Hence, our objective here is: what questions should board members be asking in performing their oversight role to ensure that senior corporate executive incorporate IG best practices?

Who is performing the IG function inside the company?

In its 2016 Annual Report, the Information Governance Initiative (IGI) – a think tank and vendor neutral consortium formed in 2014 – found a serious leadership gap in IG. The survey revealed that a surprisingly low number of organisations (only some 37 per cent) have an IG steering committee or similar cross-functional group in place to deal with information-related issues.

However, regardless of whether such a committee exists, 67 per cent of survey responders agreed that information

governance should be delegated to a single senior executive with information governance in his or her title.

Consistent with its survey results, the IGI has championed the idea of creating the position of Chief Information Governance Officer (CIGO) within corporations, where that individual is charged with owning and coordinating the solutions to complex and overlapping information challenges. In many cases, no one ‘owns’ specific information problems as they arise – certainly not in the same way as a CISO owns information security.

So too, in most organisations a vast amount of data accumulates but is inaccessible or unknown to senior management. The three primary gaps within the corporate space that a CIGO (or similarly titled individual) would fill include: (i) information-focussed leadership; (ii) organisation-wide information coordination; and (iii) being a balancer of information value and risk.

In demonstration of an emerging trend towards corporate adoption of the idea of a designated IG individual, in the past two years more than 140 IG executives and leaders (with IG in their business card titles) have participated in CIGO summits held in Chicago, where they contributed to building out what has become a playbook on what it takes to be an IG leader and what constitutes IG success.2 Accordingly, board members should be asking their CEO at the outset of any conversation about corporate IG practice: www.ethicalboardroom.com

Information Governance | Technology BE PREPARED Attention should be paid to ensuring technical issues are covered

Drilling-down on IG practices

n Has our company put into place an IG Steering Committee, comprised of senior officials from the C-suite (or their delegates), to perform a coordinating function for the formulation of policies and practices across the many various facets of IG? And, if not, why not? n Does our company have a designated official, either with the title of Chief Information Governance Officer, or something similar, who performs either an executive secretariat function for IG issues, and/or takes a leadership role for the IG Steering Committee if there is one? And if not, why not?

These questions will necessarily shed light on the present state of attention C-suite members are paying to IG best practices, as well as the maturity of the IG programme itself. Where a company has a maturing

IG programme with a designated ‘go to’ individual responsible for facets of IG, and where a cross-functional IG steering committee of some sort exists, board members and their CEO have a known place to start any inquiries they have.

Board members should, of course, feel free to jump-start a conversation about IG, irrespective of parallel lines of inquiry on the subject of cyber breach.

One important caveat that must be emphasised is that the call for a designation of a CIGO or equivalent IG senior-level position is not intended in any way to limit the ability of board members (or the CEO) to obtain feedback from any and all senior management officials of their choice, regarding specific problems or challenges that have arisen with respect to corporate data, information or records. To the contrary, a CIGO may act as an appropriate conduit for facilitating board questioning of individuals with specific subject matter expertise.

The process for getting a better handle on both the risk and the value of a company’s information assets starts with the same kind of questions as are asked with respect to cyber risk, but then diverge and expand into other areas. In general, board members would be well-advised to understand their company’s current information landscape.

What constitute the company’s information assets, and which are the most valuable?

Which consist of intellectual property?

Which are informational assets relating to a customer or consumer base? Where does the data reside physically (controlled by an in-house IT staff or in a third-party data centre, including in the Cloud? And how much data does the company hold?

These questions collectively fall under the concept of establishing a data map or engaging in asset classification – a valuable exercise not only for informing what needs to go into a cyber incident response protocol, but also simply to become more informed on information risk and information value for any would-be IG project.

In the governance space we have recently seen emerge a variety of calls for boards of directors to be asking questions of their CEOs, CISOs and CIOs about how companies are preparing for breaches Drilling down on a IG practices through agreed protocols www.ethicalboardroom.com

Winter 2017 | Ethical Boardroom 53

Technology | Information Governance Additional questions a board might ask are: How much of the company’s data is in a legacy format (e.g. on back-up tapes, or on older versions of software), and is there a plan for disposition of the data? Are the company’s electronic record holdings accounted for in existing records schedules governing shortor long-term retention and, if not, what is the plan for updating schedules to incorporate this data? Do existing record-related policies need updating, including with new provisions to account for bring your own device (BYOD) practices, or other forms of shadow IT?3 Does the company employ state-of-the-art search techniques when required to find electronically stored information in response to litigation or compliance audits? How are existing policies aligned with in-country and global privacy practices, including under the EU Privacy Shield? How is the company protecting personally identifiable information in consumer and employee data, and what are the company’s policies with respect to monetising consumer data, including in interactions with third-party data brokers?

And how does the company purport to measure ROI for its IG projects and activities?

The above questions are by no means intended to be comprehensive – they represent only suitable entry points to a more robust conversation among the board and senior officials. But drilling down in asking a CIGO or other agency senior official these types of questions quickly establishes the extent to which the company ‘knows what it knows’ (or whether it doesn’t have a clue). Establishing a baseline as to senior officials’ IG strategies is simply a form of IG due diligence, as well as proper management of risk.

Do one or more board members need some kind of IG certification or have special expertise?

Especially with the advent of Sarbanes-Oxley (SOX) legislation in the US, it has become increasingly apparent that boards of directors directly benefit from one or more individuals having a special expertise in understanding financial statements. For covered entities, SOX expressly requires that an audit committee be set up on boards of directors, and that the committee “be directly responsible for the appointment, compensation and oversight of the work of any registered public accounting firm employed by [the] issuer.”4 This, in turn, has led to the appointment of one or more board directors with expertise in auditing and financial affairs.

More recently, it has been suggested in some quarters that boards should set up a cyber risk subcommittee, charged with the responsibility of making recommendations to the full board on ways to mitigate cyber risk. Following in the footsteps of this model, boards could elect to have a standing information governance subcommittee, which may or may not decide that cyber risk is within scope.

54 Ethical Boardroom | Winter 2017

THE FACETS OF IG: IG SERVES A COORDINATING FUNCTION All of the below

Records & information management

Finance

39%

Informatics

34%

89%

44%

Data science

Information security & protection

94%

45%

Digital curation /stewardship

Compliance

88% 86%

51%

Business intelligence

52%

Enterprise architecture

55%

Analytics Big data Master data management IT management

Data governance

81% INFORMATION GOVERNANCE

55%

79%

Privacy

77%

Risk management

77%

56%

Data storage & archiving

76% 58%

59% 61% 61%

Audit Our community told us these activities are included in their concept for IG (listed as a percentage of respondents). A strong majority (83%) said this list is a complete list.

83% AGREED

Corporate governance performed properly, results in the protection of shareholder assets As the discipline of information governance is so new, it would be unusual for a board member to currently hold some kind of certification in IG, as offered by such groups as ARMA International (through its IG Practitioner certificate) or others. This is not nearly as important as having a sufficient interest in pursuing issues at the intersection of information technology, law, recordkeeping, privacy, security and big data analytics.

Regardless of the chosen structure, boards should consider engaging in requesting periodic updates from senior staff with regard to the maturity of the company’s IG profile, including the latest relevant IG metrics. The accelerating pace of change in technology demands vigilant, continuing attention. Board members should fairly demand that a CIGO or equivalent officer of IG steering committee have a well-established escalation process, which encourages business executives to bring forth newly emerging information risk issues across all relevant policy areas.

Conclusion

E-discovery

In a 2014 speech about cybersecurity, the

65%

Legal Knowledge management Business operations & management

Data derived from the Information Governance Initiative Annual Report 2015-2016.

More info at www.iginititave.com. © 2015 Information Governance Initiative.

former Commissioner for the US Securities and Exchange Commission, Luis Aguilar, opined that: “Corporate governance performed properly, results in the protection of shareholder assets. Fortunately, many boards take on this difficult and challenging role and perform it well. They do so by, among other things, being active, informed, independent, involved, and focussed on the interests of shareholders… Good boards also recognise the need to adapt to new circumstances.”5 These words are also true for implementing and maturing an information governance framework. Changing corporate behaviour is never easy, and it is especially a challenge when it comes to implementing cross-cutting IG projects or programmes. Senior executive champions are necessary, but perhaps not sufficient, in all instances to be the drivers of corporate change. The more awareness boards have of a company’s strategic plan for governing its information assets, the greater the chance that boards will play a significant role in overseeing the implementation of best practices in the IG space.

See Information Governance Initiative Annual Report 2015-2016, http://iginitiative.com. 2See IGI CIGO Playbook 1.0, https://cigoplaybook.org/why-the-cigo-is-needed/ 3 See J.R.Baron & A.R. Marcos, “Beyond BYOD: What Lies in the Shadows?” (Ethical Boardroom August 2015), http:// ethicalboardroom.com/technology/beyond-byod-whatlies-in-the-shadows/. 4Sarbanes-Oxley Act of 2002, § 301, codified at 15 U.S.C. § 78j-1(m)(2).

1

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Technology | Information Governance

How the general counsel can shape information governance

Understanding the GC’s important role in ensuring proactive information governance can help companies prepare for ever-increasing data challenges Information governance is often thought about in the context of IT efficiency, data security and regulatory compliance. While it is true that these are the most critical drivers for executing data governance programmes, there is an equally important factor that deeply resonates with a corporation’s board and C-suite: reputational risk.

Just as trust is a key and fragile pillar for relationships in our personal lives, it is essential – among shareholders, clients, customers and employees – for a business to thrive. Ultimately, top company leadership is responsible for managing reputational risk and ensuring that the overall direction of the company will uphold trust in the brand.

As we’ve seen countless times, failure to handle data properly often results in damaging data breaches, which beyond legal and compliance violations, break trust and allow doubt to become part of a company’s image. Thus, it is critical that the board views information governance (IG) as being about compliance and legal risk, as it must be, but also as an effort to instil a high standard for ethics and privacy into the company’s culture. By embracing this mindset, a corporation’s leadership can set the correct tone from the top down, building advocacy for actionable programmes that ensure safe and responsible handling of sensitive data, as well as strong compliance and efficiency.

Because the general counsel (GC) has historically been the go-to stakeholder for dealing with highly sensitive issues – primarily for litigation and investigations – the corporate legal team is uniquely positioned to lead the charge towards proactive data governance.

Given this fact, the issue of ethical obligation comes into play. In the US, federal and state laws require companies to implement reasonable security protections to safeguard 56 Ethical Boardroom | Winter 2017

Jake Frazier & Sonia Cheng

Jake is Senior Managing Director, Sonia Cheng is Senior Director, FTI Consulting personal data. There is a wide range of similar requirements around the world.

Beyond the duty to disclose, legal teams also have an ethical obligation to maintain a level of technical knowledge. In Day v. LSI Corp., in-house counsel was sanctioned for failing to document and supervise the discovery collection process and for allowing the company’s document retention policy to be ignored. In the context of IG, this is important, as legal teams must have a clear understanding about data sources and retention practices, the impact of how they

Because the general counsel has historically been the go-to stakeholder for dealing with highly sensitive issues… the corporate legal team is uniquely positioned to lead the charge towards proactive data governance choose to handle electronically stored information, and accuracy of how facts are represented to regulators, opposing parties and the courts. Ultimately, these points illustrate the fact that ethical obligations cannot be overlooked when considering the GC’s role in IG efforts.

Top issues for 2017

A handful of key themes will impact IG decisions in the coming year and should be on GC’s radar as they look to establish or evolve governance programmes. These high-priority agenda items include:

1

E-discovery process optimisation Over the last 10 years, we’ve seen an

evolution in e-discovery processes among certain corporations, such as financial services or other highly regulated organisations that face high volumes of complex litigation. These organisations were at the forefront of establishing robust in-house e-discovery capabilities and today are ahead of most. Now, with process maturity, a broader variety of organisations are beginning to take similar steps to standardise and streamline e-discovery.

Corporations are looking to optimise in-house processes, from legal holds and handling complex investigations and litigation, to stronger collaboration between legal and IT functions.

This includes vetting tools and ensuring rigorous in-house expertise, bolstering capabilities to efficiently scale to increasing data volumes and ensuring automated processes are defensible.

Cloud adoption and 2 Increased migration to the Cloud Many firms

are in the process to migrate as much of their data as possible to the Cloud in the next five years. This includes migration to Microsoft Office 365, which analysts have flagged as an increasing pain point for IG and e-discovery.

Implementation of Cloud services will introduce a variety of IG considerations, ranging across email archiving issues, data preservation requirements, cross-border regulations, data security and e-discovery processes. In order for corporations to fully realise the many benefits that Cloud services offer, there are important steps for legal teams to take before migrations begin.

As a corporation’s Cloud strategy develops, legal and compliance teams should be engaged early on to advise on regulatory and legal hold considerations, as well as varying cross-border and security sensitivities. Alain Pelluch, data privacy manager at Novartis International AG echoes this sentiment, saying: “As companies are planning to move data to the Cloud, IT should engage legal and www.ethicalboardroom.com

data privacy functions early in the process to help mitigate risk in a legally compliant, cost effective and pragmatic fashion.â&#x20AC;?

Data Protection 3 General Regulation (GDPR): This new

European data protection directive will come into force in 2018 and corporations need to spend the coming year putting a response strategy into place; ensuring there is a budget to implement the necessary programmes and technology needed to comply. Legal teams must understand that beyond European corporations, GDPR will impact any organisation that controls or processes personal data pertaining to EU citizens.

Personal data can range from an IP address to biometric data. Beginning an IG programme will help gain better control over data by informing what data exists, where it is, where it flows to and from and its corresponding regulatory obligations. Any IG effort that is aimed at getting the data house in order will help with preparing for this wide-sweeping regulation.

Globally, there are 4 Cybersecurity: dozens of laws that regulate how

corporations need to approach and maintain cybersecurity and what they must do in the event of a data breach.

IG is a key part of acting to ensure security commensurate with risk.

In January 2016, the EU Parliament approved the Network and Information Security (NIS) Directive, which, once approved by the Council of Ministers, will require EU countries to implement it into national law within 21 months. The regulation states countries must establish breach-response procedures, including expedited preservation, search and seizure, and interception of computer data (among others); and cooperate through mutual legal assistance and prosecute cybercrimes committed within their jurisdictions.

The US has similar federal and state laws that outline how corporations must respond and communicate in the event of a breach; and fines can result if reporting is not carried out in a timely and thorough manner. The Computer Fraud and Abuse Act and the Electronic Communications Privacy Act prohibit unauthorised computer access and interference to obtain data.

The UK, Canada, France, Germany, Japan, India, Singapore, Australia and others have varied laws to this extent. As cybersecurity threats and regulations evolve, it is important that legal teams remain informed about the legal aspects of managing cyber risks and map out unique programmes for handling them in each region where the corporation does business. www.ethicalboardroom.com

DATA COLLECTION Legal teams have a duty to safeguard information Winter 2017 | Ethical Boardroom 57

Technology | Information Governance

DATA STORAGE Increased use of the Cloud introduces a variety of IG considerations

and machine learning: Advanced 5 AItechnology has emerged that can

accelerate IG remediation and support in investigations and litigation. While many lawyers are beginning to adopt advanced analytics for e-discovery purposes, we are just scratching the surface of how they can be applied to IG projects. Corporations still have reticence about utilising machine learning tools and predictive coding, which only gained court approval for use in e-discovery in the UK last year; but it can be useful in taking large amounts of data and classifying it in an efficient way. Leveraging machine learning as part of an overall information classification approach can help reduce manual efforts.

Corporations must be prepared to defend how data is preserved and deleted, so it is important to maintain the right balance of people, process and technology, especially when using advanced tools. As legal teams evaluate predictive coding and advanced analytics, it is important to secure qualified experts that can advise on how the technology can best be utilised.

Taking action

With the above issues in mind, there are key actions the GC can take in partnership with the board and other C-level stakeholders to move IG programmes forward.

1

Obtain board and C-level support: To be successful, IG must be a cross-stakeholder initiative with sponsorship from top company leadership. The board should expect legal and other departments to work together to determine enterprise-wide initiatives and programmes that will benefit from solid IG practices. Stakeholders can partner to achieve their range of unique goals through the implementation of a single IG effort.

Further, when corporations build their risk framework, the process includes a standardised prioritisation of the highest risks, such as regulatory/sanctions, reputational damage, etc.

58 Ethical Boardroom | Winter 2017

With this framework in hand, legal advisors can evaluate which risk categories IG will impact and balance that with the cost and ROI of any given IG initiative. This will make it possible to make a business case for IG investments that can mitigate key risks without becoming financially prohibitive. This business case should also take into consideration the cost avoidance of possible penalties for failing to comply with the GDPR, NIS or other regulations.

Sarah Walker, VP and global chief counsel at Aon Risk Solutions agrees, commenting: “It is critical to engage the board and members of the executive committee to establish IG as a strategic priority. The programme needs to be well-aligned with the enterprise risk framework to ensure the strategic view and operational remediation (from bottom up) dovetail together to be able to achieve sustainable compliance for the long term.” your obligations: Legal 2 Understand teams, working with trusted advisors,

are critical in informing leadership as to which regulations are applicable to the corporation’s specific industry and regions of operations. A wide variety of record keeping, data protection, security and other regulatory obligations for data may apply. Defining obligations should be a holistic effort that involves the risk and compliance team, as they are the ones who may need to face-off with regulators and will benefit the most from efficient processes. started: Corporations are no longer 3 Get asking if they need to tackle IG, but rather

working on how to start. A previous Advice from Counsel study, which examined practices within Fortune 1000 legal departments, identified 30 different areas of focus for IG programmes, highlighting this challenge. While data issues can be overwhelming, teams must remember: don’t boil the ocean. Instead, prioritise remediation projects that address the highest risk areas or can provide a quick win to give

momentum. One way to achieve this is to break down IG goals into categories: 1 Protecting the sensitive information of customers and employees 2 Securing sensitive company IP 3 Arming against cybersecurity threats 4 Developing protocols and systems to ensure secure access to the network by partners and approved third parties.

These categories can help organisations take a large challenge and channel it into initiatives that are more focussed and easier to accomplish.

One example of this done well was at Blue Cross Blue Shield North Carolina (BCBSNC) in the US, which sought to provide greater visibility into corporate data stored on its various networks for investigations, improved security and more efficient data archiving.

The team at BCBSNC knew that while this was a huge undertaking, the potential long-term benefits would justify the project. FTI Consulting’s Technology experts were brought in to join the initiative. The project included security scans to identify hidden and secure folders, splitting client data into more manageable datasets and assignment of policies and controls to certain data for regulatory, legal and operational requirements.

With these in place, BCBSNC could begin to understand the magnitude and nature of the risks and opportunities inherent in its data.

In any transformational IG programme, it is generally understood that people, process and technology are key ingredients to long-term success. But often, the people part of the equation gets lost in a sea of discussions about headcount and resourcing requirements. IG must be part of the values that are embodied at the executive level. This is what enables transformation and the appropriate actions to drive long-term change. When each employee embodies trust, ethics, security and privacy, these values will translate to the services or products that the company provides. www.ethicalboardroom.com

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Global News The Americas

Canada CEO pay sets new record Canada’s 100 highest paid CEOs make 193 times more than someone earning an average wage, according to a new Canadian Centre for Policy Alternatives (CCPA) report.

The studyshows that the country’s highest paid CEOs have set a new record, with individuals receiving an average $9.5million each.

Economist Hugh Mackenzie said: “I’ve been tracking CEO pay in Canada for 10 years and nothing has changed. CEO pay keeps soaring; luxe stock option, pension and bonus packages remain the gold standard for CEOs and, despite public outrage, neither corporate boards nor shareholders are stepping in to put a lid on things.

“In the absence of corporate leadership, it falls to government to bring in laws to put a cap on the incentives fuelling soaring CEO compensation packages.”

Rolls-Royce in £671m bribery settlement Rolls-Royce, Britain’s leading manufacturing multinational, has agreed to pay more than £660million to settle bribery and corruption cases with authorities in the UK, US and Brazil. The company is alleged to have paid bribes to win deals to supply engines and equipment.

The settlement means the UK’s Serious Fraud Office (SFO), US Department of Justice (DOJ) and Brazilian investigators means Rolls-Royce will not be prosecuted over claims it used middle-men to bribe officials to secure contracts in countries including China and Indonesia.

Rolls-Royce said it would pay £497million plus interest and costs to the Serious Fraud Office (subject to approval by the high court), around $169million (£141million) in penalties to the DOJ and $26million (£21.5million) to the Brazilian authorities.

Rolls-Royce is also cooperating with Brazilian authorities investigating alleged corruption at Petrobras and its contractors.

Canadian boards ‘not prepared for climate change’ Canada’s biggest oil and gas producers appear to lack expertise in climate change at the board level, a shareholder advisory firm warns.

According to a report by the Shareholder Association for Research and Education (SHARE), public companies in some of Canada’s most carbon-intensive sectors are

60 Ethical Boardroom | Winter 2017

not currently disclosing to investors the extent to which their boards are equipped to address climate change.

SHARE has urged boards to “speak more forcefully and openly about their efforts” and warns that corporate strategy needs to take the risks and opportunities associated with climate change into account.

Sustainability important to Latin American boards Sustainability creates financial value — says 99 per cent of directors on the boards of more than 500 Latin American companies, according to a study by the Global Reporting Initiative (GRI).

Leading Sustainability from the Boardroom: The Latin American Case analysed the perspectives of 275 directors to determine how deeply Latin American boards understood sustainability.

“Four out of five directors link sustainability to the corporate strategy and the identification of risks and opportunities, or understand it as an integral part of the economic, social and environmental management of the company,” said Andrea Pradilla, director at GRI Hispanic America.

SQM to pay our $30million to resolve corruption probe

The largest economically exploitable reserves of Caliche Ore, northern Chile

SQM, one of the world’s biggest producers of lithium and iodine, has agreed to pay more than $30million in penalties following a lengthy investigation into fake invoices and accounting failures.

The Chilean company will pay the penalties to the US Department of Justice (DOJ) Securities and Exchange Commission (SEC).

According to SQM, it has been agreed that the DOJ would defer charges relating to internal accounting failures and scrap them after three years if the company agreed to pay $15.5million and be monitored for two years. SQM will pay SEC a penalty of $15million for accounting violations. www.ethicalboardroom.com

ICGN Washington D.C. Conference Hosted by IFC, in partnership with CII | 1 – 2 March, 2017.

Registration is now open, find out more and book your place at: WWW.ICGN.ORG Leading global corporate governance authority ICGN, invites you to join our first event of 2017. Ever topical, our conference will open with a panel on: Building public trust – income inequality as a business/investment risk. Brexit and the divisive U.S. presidential campaign have shown us that income inequality can have political ramifications that could impact the longterm economic trajectory of a country, creating macroeconomic shocks that negatively impact shareholder returns. What can now be done to build trust between governments, companies and societies? How can companies build strategies that are inclusive of stakeholder interests? What actions should directors take to mitigate the negative impacts of income inequality in the short and long-term? How should investors evaluate and take action on this emerging risk?

Speakers and keynotes include:

Ethiopis Tafara Vice President for Risk and Sustainability & Chief Legal Counsel, IFC

Kerrie Waring Executive Director, ICGN

Ron Lind Public Board Member, CalPERS

Douglas Frantz Deputy Secretary General, OECD

Further topics to be covered: • Stewardship in action: putting principles into practice

• Continuing the conversation on Non-GAAP

• Engaging companies on ESG strategies

• Corporate governance in action - case studies

• Shareholder engagement with controlled companies

• Dual share classes and director self-interest

Events Details Date Venue

1 – 2 March 2017 JW Marriott, 1331 Pennsylvania Ave NW, Washington, DC 20004, United States

Rates ICGN Member rate: .......................£385 CII Member rate: ..........................£465 Non-member rate: ........................£600

Special discount for Ethical Boardroom readers of 10% (£540) Please use discount code EB_ICGN when booking online at WWW.ICGN.ORG

About the ICGN The International Corporate Governance Network is led by investors responsible for assets under management in excess of US$26 trillion, our mission is to promote effective standards of corporate governance and investor stewardship to advance efficient markets and sustainable economies world-wide. Our policy positions are guided by the ICGN Global Governance Principles and Global Stewardship Principles.

The Americas | Board Diversity

Disclosure in Latin America

Board diversity is enhanced by transparency and disclosure — but not all companies in the region are ready to be so upfront Multilatinas' growth over the past three decades is unquestionable. Globalisation and internationalisation of these companies have proved decisive for their expansion, whether that's been achieved organically or through acquisitions.

The question is whether these boards are prepared to consolidate such growth and make the results sustainable. Internationalisation has variants to consider; among other aspects are the income received from foreign buyers, the hiring of international talent and the financial leverage of international investors.

On the one hand, the internationalisation that has brought benefits and forced boards to adapt their organisations, presents an undeniable challenge. That is to establish geopolitical issues that will impact businesses as a priority in the strategy and the risk map.

Changes in key markets, such as the UK and Brexit; Spain with a legislature that has begun after 300 days without a government; the US with a new government that seems to lean towards protectionism; Colombia and the peace negotiations with FARC and ELN; and Peru with a new president, will all compel nominations committees to seek talent in their boards that is prepared to rethink the 62 Ethical Boardroom | Winter 2017

Paola Gutierrez Velandía

Principal, Regional Head of Board Services Iberia & Latam, Pedersen & Partners business model if necessary – an approach that only a diverse board can undertake.

On the other side, emerging issues, such as digitalisation, anti-trust regulations and anti-money laundering compliance programmes, must be on top of the agendas for these governing bodies. Not that these challenges are exclusive to Latin America, but even though major issues have been raised in the past years in key countries specifically in the Pacific alliance are still encountering difficulties in opening the boardroom and bringing in fresh skills and backgrounds.

The lack of depth of the financial markets and the ownership structure of major groups in Latam has given regulators a major role in enhancing sound corporate governance.

A little pressure from stakeholders, such as institutional investors, can be effective when free float of companies is very limited. However, just the fact that some proxy advisors have some of the countries in the loop is a sign that companies are entering the big leagues and investors are watching over boards' conduct.

One indicator of how boards stand in terms of disclosure, composition and dynamics in Latam, is how some proxy advisors have

recommended voting in the major Latin-American markets in the past few years. In a brief investigation conducted a few years ago, for the 2013 and 2014 FYs for Chile, Perú, Colombia, México and Brazil, it was interesting to see how these agents issued recommendations on directors’ elections.

From the analysis of 254 candidates that were up for election, re-election or ratification in 2014, 38 of them received a negative recommendation, while in 2013 out the 165 candidates analysed, 50 had an against recommendation.1

Chile

According to a study of Fernando Lefort, the largest shareholder in non-financial listed companies has an average of 55 per cent of shares, while the top five shareholders account for 80 per cent of total shares.2 Though we have witnessed some democratisation following significant pressure from the pension funds on the reforms, Chile – like other countries – still has a very concentrated ownership structure.

In 2009, and the following years, the regulator issued a series of legislation acts that enhanced the principle of comply or explain.

Towards the end of 2012, the SVS issued General Standard No. 341 (NCG 341) that establishes a mechanism for the dissemination of information regarding standards of corporate governance adopted by listed www.ethicalboardroom.com

Board Diversity | The Americas

Key Committees found

Compliance

3

Other

3

IT

1

Governance

1

Ethics

1 3

Risk Compensation

1

Nominations

1

Audit Directors

3 5

■ Size of the board The average size of the board is eight members, 10 being the highest and seven the lowest numbers of directors ■ Tenure Four of the five companies have tenure of three years, according to the by-laws; only one company has an adopted tenure of four years, aligned with the continental European practices ■ Director nomination policy Only one company has a publicly available specific procedure for the directors' nomination process ■ Governance report All five companies have a corporate governance report ■ Succession planning Only two out of the five companies mentioned the succession www.ethicalboardroom.com

planning. Only one went into details on the methodology adopted for these purposes ■ Key committees in the boardroom Directors’ committee is mandatory by law

Colombia

According to a study, in the majority of companies, the four largest shareholders have more than 51 per cent of their economic rights. In addition, there is a trend towards an increasing concentration of corporate ownership. Though this has changed a little bit in the past decade, four major groups mainly control the Colombian corporate sector.5 Major breaks on self-regulation promoted

by Confecamaras in the early 2000s with the support of CIPE and the supervisory body started to enhance the governance framework in the country. Resolution 275 of 2001, abolished by External Circular 028 of 2007, as amended by External Circular 056 where major stakeholders embraced the country code, established the obligation to adopt a code of good governance for those issuers aiming to receive financial support from pension funds.

One indicator on how boards stand in terms of disclosure, composition and dynamics in Latam is how some proxy advisors have recommended voting in the major Latin-American markets in the past few years We should take into account that before the code came into force, the issuances of stock market law 964 of 2005, included provisions that specifically targeted the composition of the board, i.e. have at least 25 per cent of independent directors, the possibility to eliminate alternate directors and appoint an audit committee.

But the breakthrough enhancing disclosure came on boards’ practices with the adoption of the comply-explain mechanism in 2007 – where companies have to disclose the level of compliance on the recommendations of the country code. The code was revised in 2014.

In terms of recommendations from proxy advisors in Colombia, the investigation covered 16 companies.6 In 2014, 72 per cent of directors received a favourable recommendation and 28 per cent an against recommendation, while in 2013 the percentage was slightly different, with 75 per cent for and 25 per cent against. Companies often do not give enough information about the names or background of the candidates to be elected to the board of directors, which is something that has been changing significantly over the past

two years, although not enough. However, most companies disclose the full or an executive summary of board evaluation, which is something that even in some countries in Europe is still a pending issue.

We looked at the level of disclosure on a board’s key indicators of the current five most important listed companies according to the BVL (Colombian Stock Exchange), and the information on top market capitalisation.7 Compliance 0 Key Committees found

companies. This aims to provide to different stakeholders comparative information on all areas, especially related to a board’s dynamics, relationship between the company, shareholders and the general public, as well as the compensation and control environment.

In terms of recommendations from proxy advisors in Chile, the investigation covered 16 companies.3 In 2014, 84 per cent of directors received a favourable recommendation and 16 per cent an against recommendations, while in 2013 the percentage was very different –15 per cent for and 85 per cent against.

We took a look at the level of disclosure of key board indicators of the current five most important listed companies, according to the 500 Ránking Las Mayores Empresas de Chile (Copec, Codelco, Cencosud, Enersis and Enap).4 Exploring these companies from an array of sectors, we can see good quality in terms of disclosure of remuneration and the issues that have been discussed during a board’s key sessions, which is rare even for some continental European countries. However, we found it hard to find basic information, such as the committees of the board, and were surprised to see how the mandatory committee of directors in some companies overtake the functions of what an audit or a nominations committee must do, given the fact that the background of directors in these committees should be, at least ideally, very different.

The level of disclosure on key board indicators among the top five companies in the 500 Rànking, were as follows:

Other

3

IT 0 Governance

3

Ethics 0 Risk

4

Compensation Nominations Audit

4 3 5

■ Size of the board The average size of the board is seven members – nine being the highest and five the lowest numbers of directors. Two of the companies have alternate directors ■ Tenure Three of the five companies have a tenure of one year, according to the by-laws; two companies have adopted a tenure of two years – an outstanding practice compared to continental markets and even other Latin-American countries ■ Director nomination policy Three companies have a publicly available specific procedure for the directors’ nomination process ■ Governance report All five companies have a corporate governance report ■ Succession planning Only one company made its full succession plan available.

However, two other companies mention in their governance report or in their general policies that these issues have been or are being taken care of ■ Key committees in the boardroom Since a directors’ committee is mandatory in Chile but not in Colombia, no company has this kind of special commission. However, other committees, such as sustainability and treasury, are often present

Perú

In the case of Perú, we analysed the ownership structure of the Peruvian companies available through a study that was carried out on 180 companies listed on the Lima Stock Exchange, where 22 were excluded due to the lack of information, including Southern Perú Copper Corporation. Among these, 135 out of 168 companies have controlling shareholders.

Most of them show shareholders with a high concentration of ownership: 66 companies have controlling shareholders with more than 75 per cent of the voting rights (39.29 per cent of the total listed companies).8 Winter 2017 | Ethical Boardroom 63

The Americas | Board Diversity

Key Committees found

Compliance 0 Other

2

IT 0 Governance

2

Ethics 0 Risk

3

Compensation

3

Nominations

3

Audit

5

■ Size of the board The average size of the board is seven members, nine being the highest and five the lowest numbers of directors, as with Colombia.

Though only one company mentioned alternate directors ■ Tenure Four of the five companies have tenure of three years, according to the by-laws; the other companies have adopted a tenure of two years. Colombia seems to be self-regulated more in line with investors’ guidelines in this matter, however Perú is above the criteria of Chilean companies ■ Director nomination policy Only one company has a publicly available specific procedure for the directors' nomination process ■ Governance report All five companies have a corporate governance report ■ Succession planning None of the companies made available any policy or 64 Ethical Boardroom | Winter 2017

process on succession planning; only one company mentioned it briefly ■ Key committees in the boardroom Since the director committee is mandatory in Chile but not in the rest of the countries, no company has this kind of special commission. However, other committees, such as the corporate social responsibility, executive committee and disclosure, were presented in these companies, as well as operating commission related to business matters

México

According to certain studies, Mexican companies have a concentrated ownership and, on average, families own 44 per cent.11 Another empirical study indicates in this respect that the controlling shareholders of listed companies own, on average, 65.8 per cent of the share capital.12 In 2000, the National Banking and Securities Commission of Mexico issued the circular 11-29, through which issuers of securities must disclose on a regular basis the degree of adherence to the Code of Best Corporate Practices. In 2008, some of the recommendations of the Code were incorporated into the Commission’s legal

Succession planning and digitalisation, even though these are both critical for strategy purposes and mitigating risks, seem to remain on a reactive agenda of the boards framework. The Stock Market Act was reformed in January 2014 and additionally companies must comply with new provisions enacted by the National Banking and Securities Commission, responsible for monitoring the compliance with corporate governance provisions. However, it’s very difficult to find among the largest group of companies, comparable information in their websites – stakeholders often need to consult the Mexican Stock Exchange website.

In terms of recommendations from proxy advisors in Mexico, the investigation covered 31 companies.13 In 2014, 87 per cent of directors received a favourable recommendation and 13 per cent against recommendations, while in 2013, 45 per cent received a favourable recommendation while 24.5 per cent received an against one.

We took a look at the level of disclosure the boards of the current five most relevant listed companies, according to Forbes Global 2000.14 We should note that perhaps this market is the most challenging in terms of finding information that is user-friendly, but this is what it revealed:

Compliance 0 Key Committees found

In 2012, the regulator set up a committee for updating principles of good governance for 14 institutions from the public and private sectors. This committee was led by the superintendent of the securities market and in 2013 Perú had a new governance code.

One of the key issues that has allowed markets and investors to know more about board practices is the steps on the comply-or-explain legislation of the government of Perú.

In June 2014, the regulator approved the new report on Compliance with the Code of Good Corporate Governance for Peruvian Companies, which seeks to ensure that issuers disclose through annual reports and prospectuses the extent they have adopted the recommendations.

In terms of recommendations from proxy advisors in Perú, the investigation covered 11 companies.9 In 2014, 90 per cent of directors received a favourable recommendation and 10 per cent against recommendations, while in 2013 only two received against recommendations. One of the great advantages of Perú is the possibility of submitting to the approval of the shareholders the individual names of both the representatives of the management and representatives of the minorities in the head of pension funds.

We took a look at the level of disclosure on a board’s key indicators of the current five most important listed companies according to S&P/ BVL Peru Select Index and found the following:10

Other

3

IT 0 Governance

3

Ethics 0 Risk Compensation Nominations

2 1 3

Audit

5

■ Size of the board The average size of the board is 16 – 20 being the highest and 14 the lowest numbers of directors. Most of the companies have alternate directors.

This average is way higher than the rest of the countries in Latin America ■ Tenure We could not find the term of office in two of the companies. Two others have adopted a tenure of one year, according to the by-laws, and the last one has adopted a tenure of two years ■ Director nomination policy None of the companies that we studied had a nomination process or policy available ■ Governance report Only three out of the five companies have a publicly available corporate governance report for the past fiscal year ■ Succession planning None of the companies that we studied had a succession planning policy available.

Only one mentioned it briefly ■ Key committees in the boardroom In Mexico, we found that, according to the best practice code, most companies have to adopt a corporate practices committee, which can be classified as a governance committee. We also often found such committees as human resources, investment, executive and finance in these companies

Comparative view among countries and conclusions:

Though we are witnessing a significant wave of IPOs in these markets, the concentration of ownership is challenging boards to open up to new talent and embrace an objective nomination process of directors in order to enhance diverse boards, especially when it comes to backgrounds, emerging skills and geographical expertise. Even if the companies have adopted such policies they remain shy to fully disclosing them to the market.

Succession planning and digitalisation, even though these are both critical for strategy purposes and mitigating risks, seem to remain on a reactive agenda of the boards. Though most of the annual reports made some reference to digital strategy, only one company out of the 20 has created an official committee among directors to undertake the challenges and responsibilities.

Due to regulation, but also the self-awareness of the importance of strengthening the control www.ethicalboardroom.com

Board Diversity | The Americas environment, audit and risk committees appear to be on the top of the radar of the companies we studied. See below graphic on the most common committees among the boards of the companies we have studied.

18

12

11

11 9

9

1

1

Ethics

IT

Compliance

Governacne

Compensation

Other

Nominations

Risk

Audit

3

Key Committees found

According to their annual reports, big companies seem to be aware of the emerging opportunities and risks they are facing.

However, there seems to be a contradictory fact: while four of the company regions studied had embraced short terms in office, most of the directors (unless they are deemed independent) have remained for a long time in the company, especially in Mexico. The fact that very few companies allow investors to have a deeper knowledge on the nomination process or policy seems discouraging. It also seems that nominations committees are not fully rendering their duties when it comes to identifying the need of backgrounds and refreshment in the boardroom or they perceived to disclose such policies as ‘risky’ business when it should not be like that at all. Only Colombian companies have outranked the rest of their peers in other markets in this regard.

We are clearly advancing in the disclosure of the background of directors in big companies, especially in Colombia and Perú due to the efforts of the supervisor and the private sector. It's also made clear from the

OPENING IP But more progress on board diversity is needed

effort that the companies in these countries have put into improving their websites and sharing more information about board practices. Ninety per cent of the companies disclosed the remuneration of the board – the level of disclosure varies – but we consider this as an advance.

In terms of the size of the boards, we see that companies choose to remain with a reasonable number of directors.

When it comes to Mexico, we see that big companies have many board members, compared to their peers in other countries.

In relation to a director’s tenure, we recognise that Latin America appears to embrace the option of shareholders evaluating performance more often that some continental European countries.

We learn that Colombia and Perú often have annual elections or biannual elections. When it comes to Mexico, we were not able to establish the term of office for two of the companies, although in two cases many directors have been in consecutive terms for 20 years or more – most likely due to their executive position or the controlling stake they have in the company.

What we can see is that efforts in enhancing disclosure of boardroom practices have paid off, although we are still far from getting to a critical point where we know key aspects, such as:

decision-makers?

(We are not able to know the succession planning methodology for many of the analysed companies.) Are management appraisals for executive directors taking place?

Are they hiring executive search firms to conduct market mapping or even help nominations committees to develop director profiles that are needed on the table? To what extent has the evaluation of the board risen to this task?

■ What are boards doing to take account of the need for emerging skills?. With the challenges companies are facing, what steps are the board taking to include a new set of directors with the necessary backgrounds, such as digital, governance and geopolitical?

We have certainly come a long way, but without robust free float on Latam markets, companies must be aware of the importance of enhancing their nomination policy and succession planning. Diversity in the broad sense of the word is needed to face this new era we are entering.

■ What policies or procedures have the boards approved to identify, recommend or appoint new directors that will bring fresh and required backgrounds to the governing body?

■ What procedures or policies are in place for preparing for the appointment of key

■ Available Overall ■ Chile ■ Colombia ■ Peru ■ Mexico 16

Footnotes will be published in full online

■ Available Overall ■ Chile ■ Colombia ■ Peru ■ Mexico 16.4

9.85

8.6 7

5

5 3 1

5

3 1

0

Nomination Policy www.ethicalboardroom.com

7.4

Biographies

3

3

2

2.7 1

0

2.8 1.4

0

Succession Planning

3.2

Average Board Size

1.6

Directors' Tenure (Years) Winter 2017 | Ethical Boardroom 65

Board Governance | Cybersecurity

Board members as

cyber generals Internal audit leaders should have their risk-detection antennae up high to encourage their boards to focus on the growing importance of cybersecurity The spectre of cyberattack grows each year for organisations of all sizes and from all business sectors. Discouraging statistics and ominous predictions about the scope and continuing expansion of this business threat are as plentiful as hair on a dog. So, it is not surprising that cybersecurity has become one of, if not the, top priority for boards.

The demands on board time and resources created by cybersecurity have become a risk as already overburdened boards struggle to manage the issue, potentially taking their focus away from other business risks. This makes for a dangerous

Richard F. Chambers

President and CEO of The Institute of Internal Auditors combination that, if not well-managed, can lead to disastrous consequences for organisations.

Board members must understand the resources available to them, not just when it comes to managing cyber risks, but also when planning for the worst. Potential fallout from a major cyberattack can include damage to reputation, erosion of customer loyalty and serious challenges to business continuity and sustainability. Comprehensive disaster recovery or business continuity plans must, therefore, include a well-considered component for surviving a cyberattack.

Internal audit offers a valuable tool to help boards wrestle cybersecurity and all the attendant ills associated with a successful cyberattack. As assessors of risk and assurance providers, internal audit functions

are positioned to offer sage counsel on managing cybersecurity. Chief audit executives can become valuable partners to others within the organisation tasked with managing cybersecurity, such as chief information officers, chief risk officers and chief information security officers.

But simply identifying cyber risks and the resources to battle them is not enough. Board members must understand what factors contribute to strong and healthy relationships among those tasked to manage cybersecurity.

Often, the biggest challenge is managing conflicts created by poorly defined roles, turf battles, the influence of corporate culture and the false comfort that can come from having a disaster-recovery plan on the shelf.

Defining the scope

There is plenty of information available to establish cybersecurity as a significant business challenge. It is widely acknowledged â&#x20AC;&#x201C; and

READY FOR BATTLE Effective cybersecurity requires a unified and coordinated effort 66 Ethical Boardroom | Winter 2017

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Cybersecurity | Board Governance often repeated – that a successful cyberattack on an organisation is just a matter of when, not if. Indeed, even as awareness of the risk has grown, the number of successful attacks also increases each year.

The 2015 State of Cybersecurity Survey found nearly three in four responding organisations expected to fall prey to a successful cyberattack in 2016. The survey, an annual report from ISACA, a non-profit organisation serving the information systems industry, also found the lion’s share of reported attacks from 2015 involved two of the simplest and most easily mitigated forms of cyberattacks, phishing and malware.

Six in 10 respondents reported attacks from phishing, the activity of defrauding an online account holder of financial information by posing as a legitimate company. Five in 10 reported attacks from malware – software that is intended to damage or disable computers and computer systems. Both these schemes are easier to mitigate because they rely on victim interaction. Strong internal controls and employee training should provide enough mitigation to thwart most phishing and malware attacks, yet human error still allows for these attacks to succeed with alarming frequency.

On the positive side, the ISACA survey found 82 per cent of respondents said their boards were ‘concerned’ or ‘very concerned’ about cybersecurity/information security.

This concern has translated into significant resource commitments. Spending on cybersecurity continues to grow at a tremendous rate. Cybersecurity Ventures, a leading researcher and publisher of reports on cybersecurity, predicts cybersecurity spending will total $1trillion cumulatively over the next

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five years. Other data from Cybersecurity Ventures paints equally staggering scenarios: n Cybercrime will cost the world $6trillion annually by 2021 n There will be 1.5 million cybersecurity job openings by 2019 n Demand for cybersecurity professionals will swell to six million by 2019 n Unemployment for cybersecurity professionals is expected to remain at zero per cent through 2021 Even with demand at such high levels, most entry-level cybersecurity professionals are far from ready to do battle with evil-doers lurking in

It is useful for board members to see themselves as cyber generals, planning and executing sound battle plans against a resourceful and intractable enemy the ether. The ISACA report indicated that nearly 65 per cent lacked the requisite skills to perform the tasks related to the jobs they were seeking.

To round out the scope of the cybersecurity challenge, we must peer into the future of cybersecurity. As technology advances at seemingly breakneck speeds, businesses must learn to quickly weigh the value of each new development. The dual reality is that technological advances pose opportunity and risk and they present organisations with an unnerving choice – adopt new technology and potentially increase vulnerability to cyberattacks or take a wait-and-see approach and risk falling behind the competition.

This unsettling dichotomy is reflected in the gloomy outlook of ISACA survey respondents regarding the growing prevalence of artificial intelligence (AI). More than four in 10 expect AI will increase short-term cybersecurity risks while more than six in 10 expect it will increase long-term risks. Similarly, more than half say they are ‘concerned’ or ‘very concerned’ that the Internet of Things (IoT) – a growing technology trend where everyday objects have network connectivity, allowing them to send and receive data – will make their organisations more vulnerable to attack.

The prospects of ballooning cybersecurity costs, long-term skilled labour shortages, the battle against human error and the constant Jekyll and Hyde aspect of technological advances are enough to scare most board members into hiding.

Getting your battle plans in place Clearly, the cybersecurity challenge is a daunting one. But, as with most business risks, a well-informed mitigation strategy that is backed by sufficient resources should protect the organisation. So how should board members approach this formidable task?

It is fanciful and even entertaining to think of board members as cyber warriors doing battle with hacktivists, advanced persistent threats and logic bombs. But it is much more realistic and useful for board members to see themselves as cyber generals, planning and executing sound battle plans against a resourceful and intractable enemy. Developing that battle plan relies on board members understanding the resources available to them, surrounding themselves with qualified and trustworthy lieutenants and preparing the organisation to not just survive, but also quickly rebound from, an attack.

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Board Governance | Cybersecurity Here are seven key steps for boards to consider when building their cyber battle plan.

1

Identify the crown jewels Each organisation has many assets, but there are certain assets that the organisation cannot do without. It may be a database of customer information, intellectual property, strategic business plans, trade secrets, or grandmother’s secret recipe. This is where resources to protect and isolate are best concentrated rather than generically spread them across the environment. your defence plans 2 Build Plans should be built using a careful

mix of technology, sound governance policies and practices, crisis-management strategy and input from the highly skilled professionals who will execute the plan. the ground troops 3 Train All battle plans are only as good as the

ground troops who carry them out. Board members should support, indeed insist that, employees receive the necessary training to follow practices and protocols that make up the organisation’s cyber defence. It is telling that two major sources of cybersecurity breaches remain phishing and malware schemes. Sound cybersecurity practices can quickly render both relatively harmless, yet human error allows them to continue to plague organisations globally. for how to survive the worst 4 Plan Boards must ensure their organisations

are not just cyber savvy but also cyber resilient. Cyber resilience can be defined as the ability to resist, react to and recover from cyberattacks – and modify an environment to increase security and sustainability.1 This means having the plans and resources in place to survive the inevitable successful cyberattack. Yet, The IIA’s 2016 North American Pulse of Internal Audit survey found a scant eight per cent of respondents ranked ‘reaction’ the first or second most-effective method of responding to cyberattacks and three per cent ranked ‘restoration of services’ as most effective.2 Boards must work with management and internal audit to build crisis management and crisis communication plans to look not just at handling a cyberattack, but how to restore and sustain services and rebound from the attack as quickly as possible. a healthy and respectful 5 Build relationship with technology

Technology offers organisations the ability to boost productivity, cut costs and gain an advantage over the competition.

But it also can make organisations more vulnerable to cyberattacks. Hackers are constantly looking for ways to exploit weaknesses in organisations’ cyber defences.

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Adoption of any new technology must be considered. Build the necessary policies and protocols to protect the organisation before new technology is rolled out. stop improving the battle 6 Never plan, even if the battle never arrives

It is dangerous to view cybersecurity and cyber resilience planning as something to simply get done and checked off the list.

Organisations are dynamic and as they change, so must their battle plans. New business lines, emerging markets and other evolutions for a business create new risks and new risks require updating plans.

Cybersecurity plans gathering dust on the shelf are as useful as battle plans that do not consider the enemy’s latest troop movements.

Boards must work with management and internal audit to build crisis management and crisis communication plans to look not just at handling a cyberattack, but how to restore and sustain services and rebound from the attack as quickly as possible what can 7 Understand undermine your efforts

Even the best and most up-to-date plans can be undermined by problems with organisational culture. Boards and management can devote significant time and resources to developing great business strategies, but misaligned or toxic cultures can quickly derail their execution.

Boards must have a keen understanding of the organisation’s actual – not just stated – culture.

Internal audit’s role in cybersecurity

In an ideal world, cybersecurity plans are executed flawlessly. Everyone knows their role and follows the policies and practices designed to protect the organisation. Boards and management remain astute to changes in risk and technology and quickly act

to modify plans as needed. Organisational culture supports and strengthens cybersecurity efforts. Of course, no one lives in an ideal world.

As such, boards must constantly monitor the effectiveness and efficiency of cybersecurity practices, policies and plans.

This is where internal audit can play an essential role. Once cybersecurity plans are created, it is up to internal audit to do what it does best — test for effectiveness and efficiency of controls and protocols and provide the board and management with assurance about those protections.

Four areas where internal audit can play a significant role in cybersecurity are identified in the Pulse report. Internal audit can: n Provide assurance over readiness and response to cyber threats n Communicate to the board and executive management the level of risk to the organisation and efforts to address such risks n Work collaboratively with IT and other parties to build effective defences and responses n Ensure communication and coordination among all parties in the organisation regarding the risk The final area, ensuring communication and coordination, may be the most important.

Turf battles over who ‘owns’ the cybersecurity risk are counterproductive and weaken the organisation’s cybersecurity efforts. A unified effort where roles are clearly defined creates the best conditions for deterring cyberattacks and building and executing a cyber resilient business continuity plan in case a cyber breach occurs.

Internal audit can help organisations review and test business-continuity and disaster recovery plans. The potential for reputational harm that poorly managed business disruptions create is significant and it is far better to find faults with business continuity plans through mock exercises than in a real-life scenario.

Despite its complexity and formidable challenge, effective cybersecurity and cyber resilience are within the reach of most organisations. But they require a unified and coordinated effort. Boards are in the best position to manage the effort if their members understand the scope of the challenge, commit the necessary resources to develop and execute an informed strategy and nurture open communications and cooperation among the key players, from management and IT to internal audit.

EY: Achieving resilience in the cyber ecosystem. December 2014. www.ey.com/ Publication/vwLU Assets/cyber_ecosystem/$FILE/EYInsights_on_GRC_Cyber_ecosystem.pdf 2 The annual Pulse survey of chief audit executives is a product of The IIA’s Audit Executive Center 1

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AUDIT QUALITY IS A KEY TO INVESTOR CONFIDENCE AND PUBLIC TRUST @THECAQ THECAQ.ORG

Board Governance | Leadership

The board’s role in talent and culture Visionary boards go beyond simply setting compensation policies — they seek to understand and assess the health of a company’s culture It is well-accepted that boards play a critical role in shaping a company’s business strategy.

The senior management team may be the architects of the strategy – and the builders as well – but the board is expected to play a central role in ensuring the soundness of the plan.

Boards routinely require management teams to present three to five-year business strategies, complete with detailed financial projections, competitive analyses and the like.

But what about the board’s responsibility for leadership strategy? If business strategy defines what a company plans to do, then leadership strategy governs how a company will do it. Shouldn’t an active board be equally concerned with both?

Boards have long acknowledged their responsibility for CEO succession, but leadership strategy is more than the mere identification of a collective group of current and future executives. It is the development and stewardship of a company’s priorities and values – that is, its culture.

Historically, many boards have been loathe to interfere in the talent and leadership arena – beyond hiring and firing of the CEO and other C-suite executives. A firm’s talent management and corporate culture have largely been viewed as the purview of senior management and boards are reluctant to be seen as micro-managing or second-guessing their executive team.

Recently, however, we’ve seen a shift in that regard. A Pearl Meyer review of 1,400 US public companies shows that nearly 20 per cent have formally expanded the purview of their board compensation committees to incorporate some aspect of leadership and talent (e.g. compensation and management development committee, leadership and compensation committee, management performance committee, people resources committee, etc). This finding is consistent with our in-boardroom experience, where committee members are increasingly engaging in discussions with management 70 Ethical Boardroom | Winter 2017

Jannice L. Koors

Managing Director, Pearl Meyer that go beyond the traditional focus on the compensation and benefits packages for a handful of senior executives.

So, what should ‘visionary’ boards be thinking about?

Succession planning and leadership development

Visionary boards think beyond basic CEO succession planning. Boards should receive (at least) annual debriefs on ready-now/ ready-soon successors for all key senior positions. These debriefs should provide an overview of each executive’s position history and their most recent performance reviews.

The CEO should also be prepared to discuss his/her assessment of everyone’s strengths and weaknesses, as well as plans to address any developmental needs through rotational assignments, coaching, etc. For ready-now candidates, the overview should include the succession plan for that person’s replacement.

The discussion of ready-now candidates also needs to touch upon potential retention risks and mitigation strategies – if you think someone is ready for a promotion, chances are at least one of your competitors agrees. Boards should have Leadership opportunities to observe and interact with candidates for key C-suite strategy is more positions in formal presentations than the mere and informal gatherings. Beyond scheduled meetings, we see many identification board members actively involved in of a collective the leadership development process group of current throughout the year by volunteering to provide one-on-one mentoring and future of high-potential executives. executives. It is The succession planning and leadership discussion should also the development include a high-level, comprehensive and stewardship review of the overall team dynamics.

In the same way that boards have of a company’s begun to assess their own skills and priorities and diversity, boards should consider values — that the composition of the company’s overall leadership team. Many of the is, its culture techniques boards are using to assess www.ethicalboardroom.com

Leadership | Board Governance their own effectiveness can be readily applied to the company’s leadership team.

For example, consider reviewing a skills matrix, like that used by many boards in their self-assessment process. Does the leadership team have the combination of skills and expertise necessary to successfully deliver the company’s business strategy? Have recent or anticipated changes in business strategy changed the skills/expertise required – and have those changes created any skills ‘gaps’ in the current leadership team? Similarly, boards should also look at the demographics of the leadership team. Is the team appropriately diverse? Is it reflective of the employee population and/or the company’s customer base? Is there a mix of tenure among the leadership team? Has there been strategic consideration of which positions are best suited to internal versus external candidates?

Culture at the core

CULTURE AT THE CORE Boards must engage with employees to gauge if ‘tone at the top’ trickles down

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In the same way that boards have historically limited their compensation focus to the pay programmes for senior executives, their corporate culture concerns have tended to focus on the ‘tone at the top’. And yet, time and again we see companies dealing with scandals that are the result of actions taken by employees much lower in the corporate hierarchy. Of course, a strong argument can be made that it is indeed tone at the top that creates a corporate culture that allows (or encourages) lower level employees to act in ways that maximise short-term results but are contrary to the long-term health of the company. On the other hand, is it possible that there is a disconnect between the company’s tone at the top and the day-to-day culture at the core of the organisation? Boards need to identify ways to assess the health of the company from top to bottom – both ‘tone at the top’ and ‘culture at the core’.

Many companies routinely take advantage of board meeting dates to provide opportunities for board members to spend time formally and informally with senior management. Likewise, many companies rotate meeting locations to provide time for site visits. But such planned, scripted interactions may not provide board members with much insight into the ‘real’ working culture of the organisation. So how do boards understand and audit company culture?

Our discussions with board members suggest multiple approaches that combine formal and informal avenues. For example, while board members should be debriefed on the results of company-conducted employee engagement and customer satisfaction surveys, they can ‘validate’ those findings through other sources, such as Glassdoor (for employee comments) and customer chat sites. Obviously, employees are on their best behaviour for scheduled on-site visits, but board members can augment these interactions by looking for opportunities to engage.

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Board Governance | Leadership For consumer-facing companies, there are a myriad of opportunities for board members to interact with and observe employees at various levels in the organisation. For other companies, activities, such as attending trade shows, can afford board members an opportunity to meet with employees, customers and competitors to gain a deeper understanding of the company’s competitive positioning and reputation in the industry.

Pay equity

In the US, pending regulatory action has created increased interest in broad-based pay issues among the rank-and-file employee population. The CEO pay ratio is due to be reported by public companies for the first time in 2018 proxy statements.

Obviously, the board has long been responsible for setting CEO pay. With the advent of the CEO pay ratio disclosure, the board will need to be equally concerned with the pay of the median employee. Additionally, there is a pending regulation in the US that would require all companies with more than 100 employees to annually report gender and race pay equity statistics to the Equal Employment Opportunity Commission.

Likewise, several states have enacted, or are considering, legislation that requires

companies to prove gender pay equality (e.g. California’s Fair Pay Act).

Obviously, the recent US presidential election results have raised the possibility that these and many other pending regulations will be delayed in implementation or potentially rescinded. Still, we suggest that, considering the overwhelming and uncertain agenda proffered by the prospective administration, companies need to be prepared to comply with these pending regulations as they are currently constituted.

We further believe that issues of pay equality and fairness will continue to increase in importance, regardless of regulatory mandates and oversight. Even absent the pending CEO pay ratio disclosure, there will continue to be public scrutiny over the levels of CEO pay and the disparity of CEO pay levels and increases compared to rank-and-file US workers. On the gender equity front, we have recently seen several examples of prominent companies in the US (including Amazon, Apple and Facebook) voluntarily disclose gender pay ratios.

As a matter of good governance, boards need to ensure that management is prepared to comply with CEO pay ratio and gender/race pay equality reporting requirements. Further, boards need to help senior management consider the implications of the analyses and devise an appropriate communications strategy for all interested constituencies – media, shareholders, customers and employees.

A dis-ARMing human resources philosophy

SKILLS MATRIX Do changes in strategy affect the senior management experience required?

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While this article’s focus has been to highlight the role boards can play in shaping a company’s leadership and talent strategies beyond simply setting compensation policies, the importance of pay cannot be ignored. In fact, pay is a powerful tool that boards and senior management can use to reinforce and communicate company priorities, values and culture.

The ubiquitous phrase found in nearly all proxy statements contends that the primary goal of compensation and benefits programmes is to ‘attract, retain and motivate’ (i.e.

ARM) executives. And while companies obviously need programmes that are competitive, we think leading companies are shifting from a mindset of ‘attract and retain’ to one of ‘engage and align’. The traditional ‘attract and retain’ approach to compensation and benefits suggests a defensive posture that is externally focussed – i.e. we’re playing not to lose. In contrast, an ‘engage and align’ philosophy suggests

Management guru Peter Drucker states that ‘culture eats strategy for breakfast’.

If that is indeed true, then boards have a responsibility to understand and assess the health of a company’s culture as a critical component of the company’s ability to deliver on its business strategy a proactive posture focussed on internal goals – i.e. we’re playing to win. This shift in positioning can impact how programmes are designed and how they are communicated to employees and the marketplace.

An engagement-centred programme design focusses on: ■ Developing a holistic view of ‘compensation’ that draws on an organisation’s unique culture and incorporates both monetary and recognition-based awards ■ Realising that internal factors (business strategy and culture) carry more import than external factors (market data and advisory firm policies) ■ Addressing the evolving needs of future leaders or high-performing employees as they advance within an organisation (via age or position) ■ Incorporating a true long-term view of compensation that extends beyond three-year incentive plan timeframes An alignment-centred programme design focusses on: ■ Balancing individual accountability and rewards with the responsibility that all employees have for the overall results of the total organisation ■ Adopting a compensation pay mix that encourages necessary risk while delivering pay-outs that equitably share in the upside/downside ■ Using compensation elements that are engineered to unlock long-term shareholder value creation in an efficient manner (e.g. large annual equity awards to major internal stock holders are not an efficient use of equity) ■ Accepting that shareholders have a rightful say in how compensation should be structured A famous business maxim attributed to management guru Peter Drucker states that ‘culture eats strategy for breakfast’.

If that is indeed true, then boards have a responsibility to understand and assess the health of a company’s culture as a critical component of the company’s ability to deliver on its business strategy. www.ethicalboardroom.com

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CEO pay ratio: Stay prepared Despite rumblings that Dodd-Frank proposals will fall by the wayside with the Trump administration, companies are advised to continue with CEO pay ratio implementation plans Up until the surprising results of the recent presidential election, the CEO pay ratio was one of the biggest news stories in US executive compensation and related corporate governance circles.

The CEO pay ratio, slated for required disclosure in the 2018 proxy season, is just one of several compensation and governance related elements in the Dodd-Frank Wall Street Reform and Consumer Protection Act. It requires that companies identify the median-compensated employee within the

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company and then publicly disclose in the US Securities and Exchange Commission (SEC) filings the ratio of pay to that employee compared to pay to the companyâ&#x20AC;&#x2122;s CEO. Inserted at the last minute into the omnibus regulations, the CEO pay ratio has always been a relatively unpopular element of the Dodd-Frank regulations and the one most lacking in strong support from the mainstream institutional investor community.

While the governance community has focussed for years on the ratio of pay between the CEO and other named executive officers as a way to identity potential concerns regarding succession planning or an imperial CEO, the community historically has not been

focussed on how pay to executives compared to that of rank-and-file workers. Unlike the other compensation and governance-related elements of Dodd-Frank, which were largely grounded within mainstream governance trends at the time, the CEO pay ratio was more of an outlier, viewed as important by those in the labour community, but without broad support outside of that community.

While response from the institutional shareholder community may have been tepid, companies have strongly resisted the ratio, arguing that the number would say much more about how businesses were structured than about whether the company was compensating workers

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Compensation | Board Governance

Republicans have an ambitious policy agenda, including, notably, the overturn of the Affordable Care Act and a host of other, much more sweeping policy changes, the CEO pay ratio is sufficiently unpopular that it may very well be overturned. While many US companies have embraced this possibility whole heartedly, if there is one thing that recent events have taught us, it is that one should not put too much stock in ‘certain’ outcomes and companies would be well-advised to continue preparing for the implementation of the CEO pay ratio, even if it looks increasingly likely that it might be repealed at the eleventh hour.

Calculating the CEO pay ratio In simple terms, the CEO pay ratio requires companies to disclose: ■ The median of the annual compensation of all employees, except the CEO ■ Annual compensation to the CEO ■ The ratio between these two values

fairly. For example, two companies with identical businesses might have dramatically different CEO pay ratios, depending on whether they have decided to outsource manufacturing or keep it in-house or whether they have chosen to maintain significant operations overseas.

Companies have also been concerned that this ratio, taken out of the business context to which it is inextricably linked, will be used simply to shame them publicly for their pay practices by those wishing to promote a more populist agenda.

Even the SEC, in proposing and subsequently adopting the CEO pay ratio rules in August of 2015, commented that it did not believe comparisons of ratios across companies to be meaningful, while acknowledging that investors might glean value from monitoring year-over-year changes of the ratio within a company.

Significant legislative and budgetary efforts to repeal this provision in 2016 were curtailed by the election season, but the surprise election of Donald Trump, coupled with Republican majorities in both houses of Congress, could revive these efforts. While

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For the purpose of the calculation, annual compensation is calculated in accordance with the total compensation calculation already disclosed for named executive officers in the summary compensation table of the proxy.

Companies must briefly describe the methodology used to select the median employee, as well as any assumptions or estimates made to select the median employee or calculate their pay. Companies are also permitted, but not required, to supplement the required disclosure with a contextual narrative or supplemental ratios that they believe may be of value to shareholders in assessing the company’s CEO pay ratio.

However, in part because of concerns about the limited utility of the CEO pay ratio, the SEC regulations permit companies a significant degree of latitude in how to calculate the ratio, most importantly in how companies select the median employee.

For example, while the regulations explicitly include all employees, whether part-time or full-time, domestic or international, companies are only required to select the median employee every three years.

Additionally, companies can select any date in the last quarter of the fiscal year for purposes of defining the employee population, permitting companies with significant seasonal workforces to scope these employees out of the calculation.

The regulations also provide companies with some ability to exclude foreign employees, in instances where foreign data privacy laws preclude lawful collection of the appropriate data, or in instances where they represent less than five per cent of the

employee population and as long as all employees in a particular jurisdiction are either included or excluded in the population. While cost of living adjustments are permitted under the regulations, companies must also disclose the ratio calculated on an unadjusted basis.

And finally, companies have significant latitude in how to identify the median employee. For example, median employees can be identified using annual total compensation as required for the calculation of the ratio itself, or some other consistently applied compensation measure, such as payroll data if equity is not widely distributed. Companies are also permitted to use statistical sampling to identify the median employee.

Understanding context While it is true that for many companies the act of aggregating the requisite data and calculating the CEO ratio has been a significant undertaking, despite the latitude permitted under the regulations, it has been a largely administrative exercise.

Furthermore, for many companies, changing these ratios is not possible, as this would require either pay increases to the general employee base significant enough to increase the annual compensation of the median employee, or conversely, meaningful decreases to CEO pay.

Significant legislative and budgetary efforts to repeal [the CEO pay ratio] were curtailed by the election season, but the surprise election of Donald Trump, coupled with Republic majorities in both houses of Congress, could revive these efforts Given the impracticality of changing the ratio itself, companies are much better served by devoting time to considering how to provide additional information, which will provide shareholders with the context necessary to evaluate the pay ratio, not only within the context of the company over time, but also when comparing the ratios across companies.

For many companies, this includes a discussion of business strategy and how that strategy impacts the pay ratio. For example, a company may choose to keep manufacturing operations in-house to control quality, resulting in a significantly higher ratio than a company in a similar industry that may have chosen to outsource manufacturing.

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Board Governance | Compensation Understanding how your own pay ratio compares to peers is an important prerequisite to drafting this narrative.

Where possible, companies should seek out survey or other data that might assist in the estimation of pay ratios for likely comparators.

While other companies in similar industries are clear comparators, companies should also consider the importance of geographical comparators, particularly given the likelihood that local press will write an article comparing CEO pay ratios among local businesses. In this instance, relatively large companies are particularly vulnerable, as size appears to be one of the most important drivers of the CEO pay ratio; on the one hand, larger companies are more likely to have larger workforces, with more significant overseas populations, while on the other hand size is one of the biggest drivers of CEO pay.

EXECUTIVE COMPENSATION & GOVERNANCE-RELATED PROVISIONS, DODD-FRANK WALL STREET REFORM & CONSUMER PROTECTION ACT PROVISION

STATUS

SUMMARY OF PROVISION

Say-on-pay

Fully implemented

Requires a non-binding shareholder vote on executive compensation at least once every three years. In response to shareholder pressure, most US public companies now hold annual say-on-pay votes. Frequency of the say-on-pay vote is determined by shareholder vote every six years.

Say-on-golden Fully implemented parachutes

Requires a non-binding shareholder vote on transaction-related payments to executive officers at the time of shareholder vote on corporate acquisitions, sales or mergers.

Compensation Fully implemented committee independence

Although compensation committees were generally already independent, compensation committees are required to consider director compensation and affiliations with the company when assessing independence.

Consultant independence

Fully implemented

Compensation committee is fully empowered to engage its own advisors. Additionally, while advisors need not be independent, compensation committees must consider factors that may affect advisor independence prior to selecting advisors and any conflicts of interest raised by work of advisors must be disclosed, along with how the committee addressed the conflict.

CEO pay ratio

Final, to be implemented in 2018

Requires company to disclose the ratio of compensation paid to the CEO and the median paid employee of the company.

Pay versus performance

Initial rule proposed (April 2015)

As proposed, will require companies to disclose a chart comparing compensation â&#x20AC;&#x2DC;actually paidâ&#x20AC;&#x2122; to the CEO compared to cumulative total shareholder return over a five-year period.

Anti-hedging

Initial rule proposed (February 2015)

While, as proposed, hedging is not prohibited, companies must disclose policies applying to directors and officers regarding hedging of securities.

Clawbacks

Initial rule proposed (July 2015)

As proposed, after a material financial restatement, companies must claw back incentive compensation paid based on erroneous financial information. Incentive compensation is defined to include pay determined in whole or in part by non-financial metrics, such as stock price and total shareholder return.

Develop a disclosure and engagement strategy

Once companies understand the context in which their own CEO pay ratio will be oriented, a disclosure and engagement strategy should be developed. This may vary, depending upon the company and the context. In instances where the CEO pay ratio is viewed as well within the limits of various appropriate comparator groups, disclosure may well be brief and to the point. However, in instances where the CEO pay ratio is likely to be out of step from comparators, a more robust disclosure and outreach strategy is likely warranted. Companies should discuss the primary drivers for the ratio and tie these drivers explicitly to the creation of shareholder value. In addition to proxy disclosure, talking points should also be drafted, empowering both board members and company representatives to provide concise and persuasive responses to questions from shareholders and the media.

For most companies already engaging with shareholders on a regular basis on topics of executive compensation and related corporate governance matters, consider adding the CEO pay ratio as a regular discussion item, both to ensure that they have the necessary context to evaluate the ratio as well as to solicit feedback on their views. Influential proxy advisor ISS has already indicated that it will review the CEO pay ratio, but that its review will be focussed more on how the ratio changes within a particular company over a multi-year period.

Although not relevant in the first year, this suggests that companies should focus on how other strategic changes in the organisation, for example, a new CEO with a significant sign-on equity award or large changes in bonus

payouts, might drive significant changes in the CEO pay ratio for a particular year.

Finally, companies should be mindful of how CEO pay ratios might be viewed by internal constituencies. While companies with significant professional services populations may benefit from relatively low CEO pay ratios, it is also more likely that the median employee will fall in a group of high- potential or high-performing employees.

Consideration should be given to which employees might be adversely impacted by the new realisation that they are paid below median and how that might impact their levels of engagement and satisfaction.

Additional outreach by managers or others in the organisation may

be needed to ensure that these employees continue to feel valued by the company.

Although companies may live in renewed hope that the CEO pay ratio will be repealed, they should continue preparing for its disclosure in 2018 proxies. While the ability to change the pay ratio may be limited, how that ratio is viewed by internal and external constituencies can be influenced. Companies would be wise to devote time to crafting their message to ensure that their CEO pay ratio is considered within the appropriate context.

PREPARING FOR CEO PAY DISCLOSURES Decisions need to be made on how to present such information

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Board Governance | Executive Pay

Remuneration practices within Southern Europe Shareholder concerns and expectations have changed management incentives in recent years — but will this impact transparency?

The recent general meeting season has confirmed a substantial alignment of Southern European companies’ remuneration policies to international best practices favoured by institutional investors. The race to achieve high market approval levels has, in some cases, led companies to design ‘standard’ incentive plans, reflecting proxy advisor guidelines.

The obvious advantage is that of mitigating criticism and the potential opposition of shareholders to the adoption of the remuneration policy. But such defensive behaviour could cause the failure of the plan to address management toward the strategic goals of the company.

The design of an incentive plan should be based on a subtle balance of external influences (market, public opinion, employees, etc) and internal context of the company. The scandals and vicissitudes that have plagued several European companies should highlight the importance of including goals pertaining to the company culture and ethics dimension in the performance criteria of incentive plans. The future challenge will be to create measurable KPIs that provide the market with proof of constant alignment of management actions to the values that characterise the company’s business ethics and long-term vision.

Fabio Bianconi

Director, Morrow Sodali have been entitled to vote on a company’s policy for board members, general managers and executives with strategic responsibilities, at least with respect to the following year (forward looking), for all listed companies in Italy. To this extent, the say-on-pay provided more shareholder involvement in key decisions regarding compensation schemes increasing in time, transparency, accountability and linkage between executive pay and performance in the long term.

In 2016, we note an average minority consensus substantially in line with the general meetings of Italian listed companies in 2015 (from 74.46 per cent to 75.30 per cent) - see Figure 1 (below).

The data should also be interpreted in relation to the average level of negative recommendations expressed by proxy advisors for companies in the Italian market, which remain among the highest across the European countries that have implemented some form of say-on-pay. Concerning proxy advisors, on average, more than one third of compensation policies of Italian listed companies were rejected. Among the principal issues behind institutional dissent are the absence of disclosure relating to performance

FIGURE 1. SAY-ON-PAY VOTING 91.45%

74.02%

90.57% 74.46%

91.33%

75.30%

Italy

The introduction of an advisory vote regarding compensation policies has achieved an important result in terms of moral suasion towards company management, succeeding in a natural push to change to international best practices.

Since 2012, after the implementation of the Shareholder Rights Directive, shareholders 78 Ethical Boardroom | Winter 2017

2014 2015 2016 ■ % Minority support ■ % Overall support www.ethicalboardroom.com

Executive Pay | Board Governance criteria and/or specific targets of incentive plans (short and/or long term), the power to assign discretional bonuses, the absence of a clawback clause and the presence of provisions of more than 24 months for CEOs executive severance compensation.

The more virtuous issuers have begun implementing direct engagement with institutional investors on executive compensation through HR functions, in time to gather the motions and transform them into proposals to change current compensation policies. In other cases, contact with shareholders has been more tactical and designed to mitigate the impact of the proxy advisorsâ&#x20AC;&#x2122; negative recommendations. In spite of this effort, we have noted a decrease in favourable votes toward compensation policies which has affected, in particular, 53.5 per cent of FTSE MIB companies, in some cases modestly (<10 percentage points), in others, by a decidedly more significant measure, plummeting into and reaching a percentage of The future challenge negativity unfavourable votes higher than 50 per cent.

In 10 companies of the panel, will be to create institutional investors expressed measurable KPIs significant dissent (>25 per cent) regarding that provide the compensation policies submitted to a vote, they were characterised by different market with proof of as elements, which were regarded as being constant alignment misaligned with best practices (e.g. high severance payments, entry bonuses, of management level of disclosure regarding actions to the values insufficient objectives upon which incentive plans are based, presence of discretional bonuses). that characterise IMPLEMENTING SAY-ON-PAY External factors have radically changed management incentives

the companyâ&#x20AC;&#x2122;s business ethics and long-term vision

France

In 2013, the French government discarded the possibility of implementing a say-on-pay vote by law and decided to entrust the issuersâ&#x20AC;&#x2122; associations in introducing the framework for such a consultation. Following this decision, the AFEP-MEDEF Code introduced a provision, recommending that companies submit an annual advisory vote on any executive corporate officer compensation, received during and due for the fiscal year under review.

In particular, the code recommends one say-on-pay resolution for the chairman and

chief executive officer and one say-on-pay proposal for the executive directors in the case of a one-tier board structure. For two-tiered boards, the code suggests one resolution for the chairman of the management board and one resolution for the other management board members. The results for say-on-pay in France for 2016, regarding CAC 40 companies, is generally in line with the results of the main European markets. On average, approximately 90 per cent of shareholders voted in favour of compensation policies. We must, however, underscore that in at least one case out of four, proxy advisors recommended against the policy, determining a large decrease of favourable votes. The commitment of numerous French companies to pursue a more determined alignment to international best practices has produced a net improvement compared to 2015 approval metrics. See Table One: say-on-pay voting in France (below).

We must, however, highlight that in at least 12 cases of CAC 40 companies, shareholder consensus was slightly higher than 65 per cent, indicating the persistence of several base issues, such as the absence of performance metrics attached to short-term compensation and the presence of discretionary bonuses.

In some cases, the company failed to explain significant pay increases for executives that occurred during the previous fiscal year.

The French Macron Act, enacted in 2015, amended the minimum legal vesting and holding periods for share awards issued

by French companies that can both be reduced from two years to one. In addition, the holding period can be avoided if there is a two-year vesting period. Some proxy advisors argued that a one-year vesting period cannot be considered a sufficient period during which performance for a long-term incentive plan can be measured.

Consequently, we recorded an increase in negative recommendations from proxy advisors. As demonstrated in the following chart, the impact of these recommendations on institutional voting decisions was narrow and, in most cases, influenced by the deployment of engagement strategies. See Table Two: performance shares voting.

TABLE ONE: SAY-ON-PAY VOTING IN FRANCE Proposals 2016 2015

Nr. 74 79

CAC 40 Average Support 89.2% 86.8%

Nr. 147 150

NEXT 80 Average Support 89.1% 88.3%

Nr. 221 229

TOTAL Average Support 89.2% 87.8%

TABLE TWO: PERFORMANCE SHARES VOTING Proposals 2016 2016 * 2015 2015 *

Nr. 35 18 17 8

CAC 40 Average Support 88.1% 81.9% 86.1% 80.8%

* With at least one negative recommendation

Nr. 74 62 51 42

NEXT 80 Average Support 84.9% 82.3% 82.6% 79.8%

Nr. 109 80 68 50

TOTAL Average Support 85.9% 82.2% 83.5% 80.0%

Board Governance | Executive Pay

Spain

In accordance with the Good Governance Code and revised Capital Enterprise Act, companies must prepare and submit an annual remuneration report for advisory shareholder approval and submit, as a separate item, their remuneration policy to a binding vote at least once every three years. During the 2016 AGM season, the remuneration related proposals continued receiving negative voting recommendations. Proxy advisors are increasingly demanding clarifications and alignment with international best practices is increasingly expected.

For at least one third of IBEX35 companies, the proxy advisors opposed the remuneration policy proposals and among the 87 ‘against’ voting recommendations received by IBEX35 issuers, 20 of them (around 23 per cent of the total) were regarding remuneration-related proposals – see Figure 2: Proxy Advisor Recommendations (below).

REMUNERATION POLICIES Incentive plans should be based on a balance of external influences and internal context

FIGURE 2: PROXY ADVISOR RECOMMENDATIONS Remuneration 23%

Capital issuances 14%

(Re)election of directors 50%

Other 13%

Among the companies that submitted remuneration policy to shareholder approval, the average support was equal to 89.6 per cent in 2016, in line with other European countries.

Similar results were recorded for resolutions involving the remuneration report (90 per cent). Despite this fact, institutional investors indicated that long-term incentive plans are sometimes not subject to appropriate performance targets and therefore do not provide the necessary link between pay and performance for executives.

Concerns also have been raised over a lack of disclosure in several compensation areas, notably short-term performance targets and significant salary increases. In some cases, investors opposed the board’s discretion to grant termination benefits that could lead to excessive severance payments and the adoption of a non-transparent executive pension contribution scheme.

Israel

The ownership structure of Israeli-listed companies shows persistent high ownership concentration and limited contestability.

This situation led the regulator to propose an innovative say-on-pay model, prescribing that in companies with three or more tiers of pyramidal structure, which spotlights a

80 Ethical Boardroom | Winter 2017

potential divergence between controlling shareholders and minorities, a majority vote of independent shareholders should be binding and not advisory. The last proxy season seems to confirm a slight increase of institutional shareholders’ dissent towards remuneration policy from 79 per cent approval in 2015 to 75 per cent in 2016.

Greece

The absence of a say-on-pay mechanism results in scarce oversight for shareholders on executive compensation. While the 2013 Hellenic Corporate Governance Code recommends Greek-listed companies provide an annual remuneration report within the corporate governance statement and disclose policies and principles of remuneration for executive directors, implementation of the code is on a voluntary basis and reports detailing company remuneration schemes are not always disclosed.

In Greece, contention normally arises around director elections, auditor

External factors, such as institutional investors, proxy advisors and other stakeholders, have radically altered management incentives in recent years

elections/remuneration, board remuneration, board/auditor discharge, related party transactions and occasionally, financial statement approvals and capital authorisations. Some companies implement share equity plans for the management and certain disclosure is required by law.

Conclusions

In the main Southern European markets, stark differences continue to exist in the spheres of executive compensation and say-on-pay. Several countries, such as Greece, fail to present any form of shareholder control over management, whereas in others, such as Italy and Spain, management must submit to intense scrutiny, both ex ante and ex post. The decrease in institutional investor dissent is certainly a positive factor. However, we must ask ourselves if the achievement of this status quo will determine a slackening in the transparency of remuneration practices of the most virtuous companies.

External factors, such as institutional investors, proxy advisors and other stakeholders, have radically altered management incentives in recent years, aligning it to objective and measurable performance criteria. Remuneration plans will be expected to account more and more for the ethical and cultural dimensions of the company, capable of guiding and incentivising management over the long term.

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Can Canone onereally reallyseparate separate governance governancefrom fromcompensacompensation? tion?Compensation Compensationfrom from governance? governance?

AtAt HCM, HCM, we we donâ&#x20AC;&#x2DC;t donâ&#x20AC;&#x2DC;t think think so. so.

HCM HCM isis a leading a leading international international independent independent advisory advisory firm firm that that support support boards boards ofof directors, directors, senior senior management, management, and and control control functions functions ofof companies companies ofof allall industries industries toto make make their their governance governance (including (including compliance) compliance) and and compensation compensation more more effective. effective.

We We understand understand the the financial financial and and behavioral behavioral bottom bottom line. line.

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Board Governance | Personal Governance

Do you have a life plan?

Taking responsibility for your personal governance is a conscious, strategic and operative form of self-steering and permanent personal development Just as a well-run organisation has a guiding mission, so do managers with good personal governance. This ‘life plan’ is an ongoing project, far-reaching and carefully orchestrated. It serves as a common thread, a ‘leitmotiv’ to guide, motivate and inspire executives through uncertainty and change, success and opportunity. As a personal, core mission, its translation into action needs regular monitoring.

In this article, we explore the first of seven principles of personal governance: life plan and goals.1 While we address the individual manager, the concepts and tools can also support the development of our peers, private entourage, direct reports and teams. A life plan takes all areas of our lives into account in a meaningful and holistic way, including our social environment and the plans of our closest entourage (without allowing their expectations to automatically become our own).

Here, we can talk about the ‘life-entrepreneur’ and the ‘employee-entrepreneur’. Recent years have seen a rise in the ‘subjectivisation of work’ – where employees bring more subjective input into work in terms of opinions, motivations and demands, and in turn, work demands more ‘subjective’ input from employees, for example, self-determination, self-organisation, creativity, emotions and motivations (Kleemann et al, adapted).

Fredy Hausammann

Managing Partner, Amrop Switzerland and Vice Chair, Amrop EMEA This means that it’s becoming increasingly important for employees to take responsibility for themselves, to be self-regulated. It should not, however, be a green light for companies to delegate all responsibility for work-life balance to their employees. For example, in Leadership is an Art, Max de Pree proposes that learning organisations should consciously remove the border between work and private lives. It is the organisation’s job to support the holistic development of every employee. This implies a mutual undertaking between company and employee. Expressing success in professional or private lives as a simple ‘either-or’ question (or command) harms that undertaking.

The rolling life plan — a holistic matter

Who has one? Who needs one? Who plans for whom? Do we go on planning throughout our lives, or make a single, life-long plan?

We all have plans, which we follow more or less systematically, persistently, enthusiastically and successfully. Our plans may be related to short-term professional or private goals, or to long-term dreams.

Unfortunately, as we know, dreams may be compromised by the uncertainties that typically undermine long-term projects.

A life plan increases their chances of survival.

Personal governance deals mainly with mid- and long-term plans, their professional and private components. In the professional setting, we talk about a curriculum vitae, or SEVEN PRINCIPLES OF career plan. While planning a professional PERSONAL GOVERNANCE track is part of the life plan, it shouldn’t be the only component, and certainly not the dominant one. The life plans of ‘significant 1. Life plan others’ are also integrated; as co-planners, and goals supporting factors, important references we 2. Ethical want to consider, and so on. However, the 7. Reputation behaviour expectations of third parties don’t always need to become directives.

Personal Life planning is often triggered by a 6. Personal governance 3. Self‘fateful moment’ (Giddens, 1991), a radical interests & reflection change, a shift that feels loaded with passions destiny and forces us to pause for thought.

In managerial life, we also talk about a 5. Personal 4. Dealing warning shot across the bow; health problems development with stress strike out of the blue and we literally stop in

82 Ethical Boardroom | Winter 2017

our tracks. At such moments, we need to take stock and assess alternatives for action going forward, taking a good look at ourselves.

We mobilise our energies and new paths for development emerge. We may then follow these (often in a fairly intense way).

An ‘imaginary fateful moment’ can be used as a ‘stress test’ to kick-start life planning and regularly check its pulse. It’s easy to think of one. How would losing our job affect our need to re-orientate? This question is an exciting basis for a life plan because a) it’s part of our risk management and b) we know that most people, even if financially independent but professionally active up to their fateful moment, won’t pursue exactly the same activity afterwards (Karitzki in Brink, Tiberius, 2005).

Our personal mission — a strategic project

Like a corporate mission or vision, the life mission is strategic. And just as a corporate mission needs regular checks and adjustments, the life project should be ‘project managed’ with the same sense of purpose and professionalism.

Sennett (1999) urges that our task in the world is to create something. Shaping our own

THE QUESTION CATALOGUE

How happy am I with my life in general?

How happy am I professionally?

How have I developed professionally?

How heavy is my workload and how stressed do I feel?

What kind of fears and worries am I preoccupied by?

What setbacks have I experienced and how did these help me progress?

What kind of development steps am I personally striving for?

Questions to do with sense and meaning support this process: To what extent is what I do important to me?

Is there really nothing more important for me?

How do I define what is a meaningful task for me?

What is the essence of my (personality) profile?

How can I best utilise my resources for myself and for my social environment?

What goals do I need to set for myself, to ensure that my life has meaning and sense for me?

What do I really want for myself?

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Board Governance

‘biography’ is the most important creation of all. Still, we need to build in a healthy dose of carpe diem – an appetite for the here and now. Here, the ‘psycho-ecological man’ deserves a mention (Geissler, 2003). A modern professional, she/he wants to address different levels of needs that convey meaning: material needs and content needs. Above all, she/he seeks ‘happiness energy’ (positive energy leading to a state of happiness) and uses it to help his or her development A life plan takes personal unfold. We could all areas of conclude that people are intrinsically motivated our lives into to pursue happiness. account in a Geissler also talks meaningful about another core motive – physical and and holistic psychological ‘fullness’ way, including (in the sense of ‘satisfied’ or ‘satiated’) and to be our social fully protected from environment loss (such as that of a and the plans close one, or a job), and injury (being in some of our closest way psychologically entourage wounded). Fullness means attributing more importance to positive experiences that give us ‘happiness energy’, than to negative ones that unleash ‘frustration and injury’ energy.

Achieving ‘fullness’ can depend on how well we use our talents. Discovering and cultivating our talents are key to life planning. Here, the support of a third party is very important. Other people are good at recognising our talents and can give us vital information about what makes us different. We just have to pick up the information.

A range of tools and frameworks can support us here.

Life planning must be geared as closely as possible towards our personal aspirations and talent/s and help us aim for a high quotient of ‘flow experiences’ in our professional and extra-professional lives.2 ‘Flow’ is a state of total, concentrated dedication to an activity that momentarily stimulates us so positively that we forget just about everything else. During a task favourable to a state of flow, such moments can happen regularly. Acting within the scope of our talents, experiencing flow, means being intrinsically motivated, engaged to act, and raising our capacity for learning and development. These factors enable managers and other employees to drive PERS0NAL a company forward. They raise the GOVERNANCE engagement and motivation levels of It is a beacon for employees, deepening their emotional the way in which we lead our lives identification with the organisation. www.ethicalboardroom.com

Winter 2017 | Ethical Boardroom 83

Board Governance | Personal Governance

Writing our own biography — from norms to choices

Classic CVs, educational tracks, career and relationship models are being replaced by a host of professional and extra-professional choices at different life stages – including lifestyle choices. Being able to make a choice means having to. Difficult decisions must be faced. The security (or sense of) once on offer as part of societal traditions and rules must be replaced by self-confidence (an internally-driven sense of security).

Even if the stability and predictability of traditional psychological contracts between employee and employer may give a sense of security, they also lead to static relationships, a linearity that can inhibit dynamism and development. Today’s continuous change demands more dynamic, adaptive processes.

These cloudy, uncomputable conditions have birthed a new type of psychological contract, one moulded by self-responsibility and a heightened demand upon us as individuals.

Palazzo (2004) signals that the plunging reliability of traditional assumptions can lead to identity crises. And, as Giddens (1991) put it 'the signposts established by tradition now are blank'. Any ‘sense of direction’ is fed less by traditional paradigms and more by reflective processes.

The subjectivisation of work — it’s up to us

We are witnessing a paradigm shift in our lives, business and society. We are moving from a world of constraints, control and narrow frameworks to one of space, self-determination and self-responsibility.

Subjectivisation is also about self-realisation, participation, the desire to make a meaningful contribution.

Kastner (2004) talks about a voluntary, endless form of working. With it comes a certain degree of neglect of recreation, regeneration, the private-social environment, and the erosion of traditional employee profiles. Employees are no longer sought after as such, instead, the quest is for business partners, collaborative entrepreneurs, people who take initiatives, align with client demands, develop together with the company, taking all relevant stakeholders into account.

Even if the subjectivisation of work is a ‘venture full of conditions and contradictions’, (Kratzer, Boes, Döhl, Marr, Sauer in Beck/Lau [Hrsg.] 2004), it also seems natural and meaningful for employees to involve themselves in a company in a way that uses all their resources – this is similar to the engagement we typically find in business owners and partners. Yet the question of relationships based on fair exchange still begs an answer, because subjectivisation generally implies more time investment in work. And not everyone will find their investment is attractively remunerated. Managing our time investment is particularly important, 84 Ethical Boardroom | Winter 2017

considering dissolving borders and subjectivisation of work, and this is explored in the third principle of our series.

Here are the three most important fields of observation regarding subjectivisation and dissolving borders: n Time investment n Managing the interface between professional and extra-professional interests n Classic transactional contracts These, especially one and two, will be further explored in future articles.

Dissolving borders between work and private time and the subjectivisation of work all make personal governance and life planning more important than ever. Personal governance is a way of managing and containing dissolving work borders and can help us make the very best of the subjectivisation of work. How can we go about this?

YOU, Inc. — a liberating status

One sign of the subjectivisation of work is the emergence of ‘YOU, Inc.’. We achieve that status when our dependency upon a particular employer Professional drops, because our skills are in demand in the market. independence can Whether we’re fully employed be interpreted or working as an independent in different is irrelevant. The power imbalance between employer ways, but it’s and employee is transformed mostly about our into a partnership in which both players enjoy more material security flexibility and room to in expectations has become a and rights manoeuvre. Reaching YOU, source of external pressure.

Inc. status can be one goal of Some research suggests that life planning, creating career options and very materially oriented people tend towards a degree of professional independence. bad moods and depression. They have fewer It can be also be a coping strategy – a friends or stable relationships, lower levels of heightened awareness of our professional curiosity, creativity, and interest in life, and independence can relieve the pressure of get bored more quickly. (Csíkszcentmihályi, difficult professional situations.

2003). Material striving (addiction, even) Professional independence can be could inhibit true satisfaction and happiness. interpreted in different ways, but it’s mostly Rolling life planning gives us a chance about our material security and rights. to think regularly about our relationship with the material world. It can help us Material wealth spot possibilities to raise our satisfaction via sources other than material ones. In — a happy marriage?

The greater our financial resources, the more this way, we can raise our ‘life satisfaction room for manoeuvre we have to independently competence’ and ‘happiness ability’ shape our life plan. Although money is, of (Dietman, 2003, de Mello, 2002). course, only one aspect of wealth, being aware Sense and happiness of our relationship with our material needs and aspirations is a very important part — fuelling the life plan Not only are sense and happiness closely of life planning, and that relationship can related, they also have a central place in life broaden or narrow our scope of lifestyle planning. As Nietzsche put it: “He who knows choices. Questions include: What part of my the why of life, can bear almost any how.” Still, material wealth is worth holding on to? What we should take happiness with a pinch of salt do I aspire to? How much do I need to earn? and question Nietzsche’s assumption that The material expectations of our personal “the unconscious goal in the evolution of every entourage also play a major role. It’s important conscious being is its ‘highest happiness’”. Ulf to ask ourselves whether our own needs are in Dettmann (2005) has raised an important link harmony with theirs, or whether a divergence www.ethicalboardroom.com

Personal Governance| Board Governance

STEPS TO SUCCESS 'Life plan and goals' are the first building blocks of personal governance

Creating new conditions is sometimes hard work, but… do it today!

Sometimes, even under the seemingly right conditions, Good Luck doesn’t arrive. Look for the seemingly unnecessary but indispensable conditions in the small details To those who only believe in chance, creating conditions seems absurd.

Those who create the conditions are not worried about chance Nobody can sell Good Luck. Good Luck cannot be sold. Do not trust those who sell luck After creating all the conditions, be patient, don’t quit. For Good Luck to arrive, have faith Creating Good Luck means preparing conditions for opportunity.

But opportunity has nothing to do with luck or chance; it is always there

6 7

8 9

10

The 19 happy people factors and the 10 Rules of Good Luck have a lot in common with the principles of personal governance. Personal and corporate governance are not just a matter of luck. They are a matter of Good Luck.

Implications for organisations If individual managers need to take a set of considerations into account, so, too, do organisational talent architects. As follows:

between active life planning and happiness.

He refers to a study in happiness psychology that found 19 factors in people who describe themselves as happy and content. Happy people: n See themselves as masters of their own lives n Have a clever combination of short and long-term goals n Love what they do n Do not think in terms of problems, but in solutions n Do not solve their problems on their own n Invest a lot of time and energy in their social relationships n Know how to make the best of their abilities n Put nothing off until later n Plan ahead n Are grateful for pleasant aspects of their lives n Are not complacent n Are working people n Can wait a long time for rewards n Know when to stop n Are active people n Are sporty people n Live in the present n Are in a position to let go and relax n Have been lucky (but not just lucky) Dettmann concludes that on the basis of positive life circumstances, “working towards www.ethicalboardroom.com

and reaching the goals we ourselves set, are a rich basis for happiness and contentment”.

Luck, plain luck and good luck

Let's now look at a potentially exciting link between the last happy people factor, Dettmann's conclusion that working towards our goals and reaching them are a rich basis for happiness and contentment, and another aspect of happiness, Good Luck (Rovira, Trias de Bes, ESADE, 2004). The authors distinguish between luck, plain luck (luck outside our influence), and Good Luck, (within our influence), setting out 10 rules:

1

Luck doesn’t last long, because it doesn’t depend on you. Good Luck is created by each of us: that’s why it lasts forever Many are those who want Good Luck, but few are those willing to pursue it If you have no Good Luck now, it might be because you’re under the usual conditions. To have Good Luck, you must create new conditions Finding new conditions for Good Luck does not mean looking for our own benefit only. Creating conditions, helping others, makes Good Luck more likely to appear If you postpone the creation of new conditions, Good Luck never arrives.

2 3

4 5

n Aspirations and talent n Dissolving borders between the work time world and the private time world n The subjectivisation of work n YOU, Inc. n Material aspirations, satisfaction, meaning and luck The mission of an organisation needs to align as much as possible with the personal governance and life planning needs of its managers. Only then can it create a robust, long-term connection between people and organisation and build a critical mass of cohesion. Only when the organisation knows the true talents of its employees can these be mobilised by the organisation and by its individuals. Moreover, dissolving borders between professional and extra-professional interests contain hidden opportunities and risks.

Influence needs to be carefully applied and borders dissolved throughout the organisation.

The more strongly an organisation can establish an emotional bond between itself, its strategic goals, its managers and beyond, to all its employees, the more its work will carry sense and meaning. Thanks to this shift, a multi-facetted form of motivation can be installed that is focussed on more than purely material incentives.

1 This article series is based on Personal Governance als unverzichtbarer Teil der Corporate Governance und Unternehmensführung – Fredy Hausammann, (Haupt Berne, 2007). Translation and editing: Steffi Gande, Editorial Board Member, Amrop. 2Mihály Csíkszcentmihályi

Winter 2017 | Ethical Boardroom 85

Ethical Boardroom Keeping it Above Board

â&#x20AC;&#x153;Essential reading for boards who want to stay ahead of the governance curveâ&#x20AC;?

Board Leadership | Corporate Governance

Reaching for the ‘reset’ button

Behavioural shortcomings and operational weaknesses are at the root most company failures. Both can be avoided if boards go back to basics Recently appointed Wells Fargo chief executive officer Tim Sloan deserves credit. Almost immediately after the departure of disgraced former CEO John Stumpf from the building, Sloan delivered a speech to all employees to apologise for the fake accounts scandal that had beset the company.

That Sloan delivered an apology was a much-needed first step on the path towards redemption, even though “we’re sorry for the pain” sounded like an apology for the angst employees faced rather than the fake accounts action itself.

Sloan’s initial action is indeed commendable, even if it left a bevy of questions unanswered.

The appointment of a senior insider (Sloan is a 29-year company veteran) to the position vacated by Stumpf, as well as to the board, is curious, to say the least. Sloan would have been aware of the fake accounts scandal, yet he got the nod for the top job. The appointment raises questions about the due diligence and recruitment processes the board utilised.

Did the board know about the decisions and activities that perpetrated the scandal?

If so, why has the pursuit of accountability not reached the boardroom? If the board was not aware, why not? That the board has remained silent is telling.

Meanwhile, across the Atlantic, Theresa May was becoming familiar with her new surroundings at 10 Downing Street in London just as the wheels fell off the Wells Fargo stagecoach. The newly-elected British Prime Minister wasted no time making her views known, delivering a strong message to the business community in the UK. Much of her message was aimed at the boards and executives of publicly listed companies, proposing measures to curb (perceived and real) corporate excess

88 Ethical Boardroom | Winter 2017

Peter Crow

Accredited company director (CMInstD) and board advisor in the form of excessive remuneration, hubris and a flagrant disregard of some stakeholders.

Among other measures, Prime Minister May proposed that an unspecified number of seats should be reserved at the board table for employee directors. The proposal was widely reported and discussed, albeit with a mixed response. The Institute of Directors and the unions, for example, offered strong support. In contrast, many business leaders expressed wonderment, as if to ask whether the Prime Minister’s advisers had confused representation with the duty to act in the best interests of the company. The government has since rowed back from compelling boards to appoint employee representatives.

While progress has been made in recent years, the level of understanding of how boards should work if they are to exert influence from and beyond the boardroom remains incomplete Wells Fargo now joins an ever-growing roll call of avoidable corporate missteps and failures (other recent examples include HSBC, FIFA, Volkswagen, Toshiba, Solid Energy, BHS and SportsDirect). Many of these seem to have emanated from the boardroom – through the actions (or inaction) of the board of directors. Notwithstanding the thousands of commentaries, opinion pieces, blog discussions and watercooler debates amongst armchair ‘experts’, the most visible response to these and earlier failures has come from politicians, legislators and regulators –

their natural response being to impose new statutes and obligatory codes of practice.

Will these measures have the intended effect?

If history is any guide, probably not. Previous statutory reforms, codes of practice and other compliance measures introduced in response to corporate failures and the behavioural shortcomings of directors (and boards) have done little to improve board effectiveness or firm performance. They have not assured company continuation, either. Indeed, they were insufficient in averting several high-profile company collapses in the early 2000s and may have contributed materially to both the global financial crisis of 2008-2009 and some of the more recent corporate failures as well.

While specific causes are many and varied, two general themes are apparent: behavioural shortcomings (e.g. moral failures of directors and executives, ineptitude in the boardroom, fraudulent behaviour and activities, excessive risk taking and hubris) and operational weaknesses (an ambiguous understanding of corporate governance, company vision and unclear company vision and strategy, the focussing of boards on compliance and monitoring activities).

Clearly, corporate governance has entered troubled waters.

On one hand, the task of directing the affairs of the company has become more complex as extra layers of compliance are added. On the other hand, expectations from shareholders and other stakeholders continue to rise. Boards are rapidly reaching the point where the dominant focus is on ensuring relevant statutes and regulations are complied with, and discovering ways of minimising or avoiding compliance costs, or both.

The myriad of different definitions and ‘best practices’ that have been promoted by directors’ institutes, academics, consultants and others has exacerbated the problem. Many directors have found themselves confused, struggling to contribute effectively – even to

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Corporate Governance | Board Leadership

TIME FOR A REFRESH Many directors have lost sight of what corporate governance actually is

the point of losing sight of what corporate governance actually is, or so it seems.

The ubiquitous use of the term ‘corporate governance’ seems to have lulled directors, consultants and regulators into a false sense of security as well – the parties assuming that a common understanding exists. But that is often not the case. The term is now routinely used in a variety of ways. These include to describe the board’s oversight of the activity and conduct of managers; the activities of the board; the board itself (“we’ll need to get the governance to make that decision”); and, in a few cases, the business ecosystem and legal framework beyond the company (expressions include ‘system of governance’ or ‘whole-of-enterprise governance’). Is it any wonder that directors are confused and boards struggle to understand their role, much less contribute effectively?

If boards are to be effective, the problems and ambiguities alluded to here must be resolved. Straightforward understandings need to emerge. On paper, effective boards are those comprised of a group of people with the capability to assess situations critically; make decisions of various types, especially strategic decisions; and, oversee management effectively. The goal is to ensure both strategic priorities are achieved and intended performance goals are achieved, in the context of the agreed purpose of the company. The board needs to know how the business is performing, relative to the agreed purpose and strategy, and whether expected outcomes and associated benefits are being achieved (or not).

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Winter 2017 | Ethical Boardroom 89

Board Leadership | Corporate Governance

How might this be achieved in real terms?

If the corporate excess and malfeasance that has been characteristic of the failures and missteps referenced here is to be corralled, the underlying basis of corporate governance needs to be reclaimed. A singular understanding of the term is crucial. The term governance (an active noun derived from a Greek root, kybernetes, meaning to steer or pilot, typically a ship) provides a useful starting point.

Richard Eells, a researcher, was the first to use the term in a corporate context. He introduced the term ‘corporate governance’ in 1960 to describe the structure and functioning of the corporate polity (i.e. the board of directors). Some 30 years later, Sir Adrian Cadbury proposed his now widely-cited definition: corporate governance is “the means by which companies are directed and controlled”. Though worded differently, these two definitions are both consistent and stable – corporate governance describes the work of the board.

Thinking more broadly, what of the wider context, the statutes, codes and regulations under which companies and their boards operate? Should these elements also be included within the scope of corporate governance, or do they provide the operating context within which boards practise corporate governance?

If the scope of corporate governance is expanded to include the operating context beyond the boardroom, it quickly becomes ubiquitous, spanning the business ecosystem and legal framework, the board and its activities, and even the company’s operations and the functions of management, leadership and operations. Such an expansive understanding has been mooted. However, it introduces ambiguity and is less than helpful – analogous to failing to distinguish between the rules of the game; the game itself as played; and, the result having played the game. Eells’ and Cadbury’s definitions suggest that a clear distinction is appropriate.

Ultimately, directors need to take responsibility for their actions; invest time understanding the business of the business; and take the tenet of collective responsibility

90 Ethical Boardroom | Winter 2017

seriously. More specifically, directors need to accept that their primary duty is to act in the best interests of the company (in accordance with prevailing statutes and regulations), not the shareholders, employees, managers, suppliers or any other party. This includes ensuring the purpose of the company is clearly defined; a clear strategy is in place (ideally, having contributed to its development with management); monitoring the activities of management; not allowing the company (management) to trade recklessly; and, importantly, making tough remedial decisions if required. If the viability of the company is at risk, for example, the board is duty-bound to act – and act it must, as unpleasant as that action may be.

Directors need to take responsibility for their actions; invest time understanding the business of the business; and take the tenet of collective responsibility seriously Directors need to be fully engaged in their work if they are to discharge their duties effectively, by making appropriate enquiries and asking probing questions both before and during meetings to ensure they clearly understand the business of the business (a weak point of many directors). Active engagement and adequate knowledge are crucial foundations, not only for effective decision-making, including strategic decisions, but also the determination of corporate purpose; the formulation and approval of strategy; and, the monitoring and verification of both strategy implementation and subsequent business performance.

Further, boards need to ensure the performance–conformance dilemma is appropriately managed. Considerations include whether the board is spending adequate time on forward-facing, performance-related matters (especially strategy and strategic decision-making, but

also policy-making), or (as is more common than many directors admit when surveyed) is most of the board’s time being spent on compliance and conformance matters or, worse still, rubber-stamping management’s proposals? Other considerations include whether the directors are strategically competent and operating with a sense of purpose. The close interaction of the board and management as agreed goals are pursued is also recommended, as a platform for more effective decision-making and board contributions. However, this requires the board to develop high levels of trust and have the social maturity and collective efficacy to work together and exert control constructively.

Boards should discuss these and related matters periodically (perhaps annually), to ensure they are appropriately focussed on and adequately equipped to pursue the value creation mandate. A formal, externally facilitated board and governance assessment can offer useful insights as well, so long as any recommendations arising are both reported to shareholders and acted upon by the board.

Bob Garratt reminds readers in his book The Fish Rots From The Head that the role of the board is actually quite straightforward: to govern by giving direction and steerage to the company, and to both resource the executive and hold the executive accountable for achieving the overall purpose and agreed strategy. If directors embrace these suggestions, enforced structural provisions may no longer be required. But this relies on directors behaving well and doing ‘the right thing’, a reliance that has a chequered history.

While progress has been made in recent years, the level of understanding of how boards should work if they are to exert influence from and beyond the boardroom remains incomplete.

If answers to this difficult question can be found, they will probably have significant implications, leading to a clearer understanding of corporate governance and improved guidance for board practices, director recruitment and on-going director development.

While some directors may struggle to come to terms with the implications, the flow-on effects for long-term sustainable business performance, economic growth and societal well-being are likely to be significant.

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Board Leadership | Boardroom Culture

10

high-performance board barometers

Proactively shaping a culture, based on the best of all possible cultural norms, should be the aspiration of any boardroom. So how does your company fare?

For the longest time, I was puzzled that, despite best efforts in time, money and relationshipbuilding to get just the ‘right’ people to serve on a board, that ‘perfect’ high-performing board remained elusive.

What I have found over 25 years of research – both anecdotal and academic – is that the puzzle can be solved by adopting and embedding 10 cultural norms.

Our first response when our board falls short, or we are confronted with boardroom dysfunction, is to blame the very people we worked so hard to recruit to our board.

However, often the problem lies not in the people, but in the underlying culture.

It doesn’t help that most directors fit into the established boardroom culture rather than proactively deciding what kind of board they want to be. If you are not leading your culture, your culture is leading you.

Cultures can – and need to – be changed. While a daunting task that takes perseverance, championing and time, any board can set a course toward becoming a high-performing board. This begs the question, what does a high-performing board look like?

Debra Brown

President and Chief Executive Officer of Brown Governance Inc This article describes the top 10 cultural markers of a high-performance board. It also provides a practical tool to assess your board against those markers.

Ultimately, becoming a high-performance board that is centred – a board that proactively builds a culture based on the best of all possible cultural norms – should be the aspiration of any board. Here are the top 10 markers of a ‘high performance’ board.

1

Practise participative leadership: Participative leadership means that, as far as is reasonable and possible, decisions are made

with the most participation from those making them and those affected by them.

This type of leadership can be particularly challenging for boards as they are typically faced with making big decisions in a limited amount of time with only the information they have in front of them. The board chair is the key to successfully ensuring maximum participation and input, balanced with flexible and nimble decision-making.

Watch your board chair to test how participative your leadership decisions are.

Does the chair draw on all members of the board? And, are your board’s decisions well-informed with the views of those who will be affected by your decision? responsibility: In the healthcare 2 Share sector, a shared responsibility model

means that everyone gives a little so that all can benefit. The same principle can be applied in the boardroom. No one director is more

HIGH EXPECTATIONS The Chair is the pivot point – culture change will not happen without their intentional and active leadership 92 Ethical Boardroom | Winter 2017

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Boardoom Culture | Board Leadership responsible than another. No one director has the authority to make decisions on behalf of all directors. All directors are equally responsible and accountable, while at the same time these are equally shared. For this reason, all directors must give something so that the organisation receives the benefit.

In the real-world boardroom, things can play out quite differently from this. Some directors hold more sway than others for any number of reasons. Perhaps they enjoy a certain skill set, such as an accounting or legal degree, are a well-connected industry leader, have been around for a long time, or have a strong personality that commands attention.

Watch the engagement level of your board members. Is there full engagement of all directors – not just those with a specific expertise, a loud ‘voice’ or position in the ‘family’? Do some directors carry more of the burden than others?

Participative leadership

Focussed on the task of the board and the results of the organisation Rapid and nimble

Shared reponsibility

Future oriented

Healthy risk appetite

Aligned with purpose

as a board member is in service of the purpose – the mission of the organisation. Too often directors serve on boards for all the wrong reasons—for money, ego, influence, power, or they just can’t say no—when their legal, fiduciary reason for being on the board is to serve the organisation’s purpose and to act in its best interests.

Before agreeing to serve on a board, you must ask yourself ‘why’ am I willing to serve on this board and, am I able to put this organisation and its purpose ahead of my own? If the answer to the ‘why’ question is anything other than you feel you can uniquely add value to the purpose of the organisation, or if you cannot put its best interests ahead of your own, then you should not agree to serve.

Test this on your own board – does your board act in the best interest of the organisation or are individual directors allowed to act in their own self-interest?

4

Using diverse and creative talents

Encourage high levels of communication: The primary responsibility for ensuring a message has been received lies with the sender, not the recipient.

Operating at a high communication level means your interactions with management, shareholders and stakeholders alike:

Comfortable with dissent

n Are open and transparent, with full disclosure n Safeguard against confidentiality breaches n Ensure conflicts of interest are declared

Put together with high-level communications

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with purpose: To be aligned with 3 Align purpose means that everything you do

And it means that everyone on the board has complete access to the same information.

In other words, the board should invest the effort and put policies in place to support information flows that are easy to see and

Culture change puts pressure on people to change. Boards, led by their chair, will need to actively reframe cultural expectations in the minds and hearts of the people involved understand by those who legitimately need to see and understand.

The board must also take responsibility for the information it receives from management.

Boards regularly complain about receiving too much, too little, or the wrong level of information. It is the rare board, the high-performing board, that proactively lets management know what it wants and needs. on the tasks of the board and 5 Focus the results of the organisation: A

board member once told me they know when they have gone over the board-management line because they start having too much fun!

Serving on a board is hard work. It is also cyclical and repetitive. After all, governance is the system by which organisations are directed and controlled and boards are responsible for the governance of their organisations. Systems are not that much fun, but they are necessary for good governance.

The governance system is the work of the board and it requires members’ undivided attention and focus. Is your board focussed on the strategic governance work of the board, respecting the board/management line and readily moving beyond the task to results? Or does it get bogged down in operations, management-level decision-making and generally the fun parts of operating a business?

Winter 2017 | Ethical Boardroom 93

Board Leadership | Boardroom Culture toward the future: Just as 6 Orient individuals who are future-focussed

are happier and more successful than those who are present or past-focussed, so the organisation that remains optimistically future -focussed is more successful, innovative and has a higher tolerance for risk and ambiguity.

High-performing boards remain focussed on their forward-looking strategic role in direction and control. At the same time, they make strategic decisions by integrating lessons learned from historical facts, present realities and reasoned projections.

7

Make use of diverse and creative talents: There is significant value to boardroom diversity. Gender, visible minorities or geographic diversity are but proxies for true diversity. Real value-added

diversity lies in diversity of thought, experience and skill sets.

At its best, true diversity brings healthy debate, a view of business problems from different angles and experiences, fresh ideas, perspectives and enhanced creativity.

High-performance boards exhibit a deep respect for the background, skills, experience and attributes of all directors and its management team along with a communal desire for innovation.

It is for this reason that high-performing boards are attentive to policy, risk oversight, best practice and performance measures.

These due diligence processes and systems are in place long before they are faced with making that next big decision. The decisionmaking foundation has been laid so they are ready to respond rapidly when called on.

rapidly to organisational 8 Respond needs: Boards should never become a

governance regulation and even director education programmes has been a tendency to significantly reduce the risk appetite and tolerances of boards of directors.

An inordinate amount of focus has been placed on the downside of risk at the cost of upside opportunity. A high-performance board has a risk appetite suitable for the organisation and the sector it is in – it decides on opportunities in a calculated and measured way, while at the same time acting with courage, wisdom and common sense.

stumbling block to organisational nimbleness.

When faced with pressure to make a quick decision, should they take the time to constructively challenge management recommendations, test their assumptions and consider the pros and cons? Yes they should!

TAKE THIS SELF-ASSESSMENT AND SEE IF YOURS IS A HIGH-PERFORMANCE BOARD! Evaluate how well your board currently performs in each of these cultural norms using the following as a guide:

5.

4.

3.

2.

1.

N/K

Outstanding, excellent, no improvement needed Better than satisfactory, less than completely outstanding Fully satisfactory, meeting the standard in this area Less than fully satisfactory, but not lowest rating Improvement needed, not meeting standard and/or developmental No knowledge or not in a position to assess the board in this category

CULTURAL NORM

TO WHAT DEGREE DOES THIS HAPPEN AT YOUR BOARD?

1. Practise participative leadership: Your board is not personality driven, the chair draws on all members of the board — not just those he/she knows best or who speak the loudest.

1 4

2 5

3 NK

2. Shared responsibility: There is full engagement of all directors — not just those with a specific expertise, a loud ‘voice’ or position in the ‘family’? No directors carry more of the burden than others.

1 4

2 5

3 NK

3. Aligned with purpose: Your board acts in the best interest of the organisation — individual directors do not act in their own self-interest.

1 4

2 5

3 NK

4. High levels of communication: There is open, transparent, full disclosure, no confidentiality breaches or undeclared conflicts of interest and everyone has access to the same information. Your management team knows what the board’s reporting expectations are.

1 4

2 5

3 NK

5. Focussed on the tasks of the board and the results of the organisation: Your board is focussed on the strategic governance work of the board, respects the board/management line and readily moves beyond the task to results.

1 4

2 5

3 NK

6. Oriented toward the future: Your board makes strategic decisions by integrating lessons learned from historical facts, present realities and reasoned projections.

1 4

2 5

3 NK

7. Use of diverse and creative talents: There is a deep respect for the background, skills, experience and attributes of all directors and management team along with a communal desire for innovation.

1 4

2 5

3 NK

8. Rapid response to organisational needs: Your board is highly attentive to policy, risk oversight, best practice and performance measures so it is able to respond rapidly when called on.

1 4

2 5

3 NK

9. Healthy risk appetite: Your board has a risk appetite suitable for the organisation and the sector it is in — it decides on opportunities in a calculated and measured way, while at the same time acting with courage, wisdom and common sense.

1 4

2 5

3 NK

10. Comfortable with dissent: Your board maintains solidarity while being comfortable with dissenting voices, challenging assumptions and building consensus.

1 4

2 5

3 NK

94 Ethical Boardroom | Winter 2017

a healthy risk appetite: One of 9 Have the perverse effects of modern corporate

comfortable with dissent: 10 Be Life and board meetings, just seem

easier when we all agree with one another.

But is that best for the organisation? Or, is there value to be had in dissenting views?

When dissent is allowed in the boardroom it builds critical thinking, collaboration, mutual respect and board member engagement. It is often the dissenting voice on which a strategic decision may turn and an organisation gains the courage and confidence to act or it is brought back from the brink. Building a board that is comfortable with dissent takes a great chair and emotionally mature directors. High-performing boards maintain solidarity while being comfortable with dissenting voices, challenging assumptions and building consensus.

Culture change puts pressure on people to change. Boards, led by their chair, will need to actively reframe cultural expectations in the minds and hearts of the people involved. Doing so will bring real change to individuals and therefore to the board and the organisation.

At other times, it may mean replacing individuals who are at odds with the preferred culture and are just not willing to make the changes asked of them. Boards should not fear either of these outcomes in their quest to become a high-performance board. Change the culture and you change the people – or you may need to change the people!

CREATIVITY A board should have a communal desire for innovation

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Board Leadership | Brexit

Gillian Karran-Cumberlege & Luke Main Gillian is a Partner and Luke is a Research Associate, Fidelio Partners

Board composition in the post-Brexit era Diversity of perspective and experience, as well as vision and imagination, are critical board qualities in this time of exceptional change On 23 June 2016, 52 per cent of the UK voting populace voted in favour of leaving the European Union. In the space of 24 hours, the UK Prime Minister had resigned and the pound had plummeted – introducing a new era of uncertainty for citizens, corporates and boards.

As a board development and executive search firm with a UK and pan-European client base, Fidelio is keenly interested in the implications for board composition.

Given the purpose of the board to provide oversight, accountability and strategic direction, it is unsurprising that such a momentous change as the Brexit vote will influence the skills and experience that are required around the boardroom table. In this article, we explore both what we have seen to date in terms of post-referendum impact on boards and also share our expectations regarding future implications.

The run-up and immediate aftermath

To better understand the future impact of the Brexit vote on board composition, it is worth recalling the approach of boards in the run up to the referendum. While most of the business community was pro-Remain, there were deep divisions within UK boardrooms with, for example, one leading FTSE board accommodating the views of a clearly pro-Remain CEO and a publicly 96 Ethical Boardroom | Winter 2017

pro-Brexit chairman. Beyond internal divisions on which way to vote, boards were also divided on how to respond and engage with the referendum campaign. While many board members were individually pro-Remain, boards were hesitant to be seen to be exercising political influence.

For many companies, it was also clear that a significant portion of the customer/client base were pro-Brexit. There was evidence of chairmen expressing a view publicly on behalf of one organisation in their portfolio, but elsewhere refusing comment. As the polls tightened, several companies refused to communicate more profusely and there was arguably a whiff of panic.

It is interesting to note that German companies with major investments in the UK often felt more comfortable than their UK competitors expressing a view on the potential economic impact of a Leave vote. Indeed, in late 2015, Fidelio held two separate breakfasts with FTSE 100 corporate affairs directors and FTSE 100 board directors in the context of the approaching Brexit referendum. It was telling that the corporate affairs directors were much more awake to the potential for a Leave vote and several months out effectively called the eventual referendum outcome – recognising the vote would be emotional, close and could well result in a Leave majority. The board directors were much less clear and few companies seemed to have clear strategies at this point.

Fidelio, like much of the business community, was fearful that a Leave vote could deliver a very substantial shock to the

UK economy and beyond.

In the immediate aftermath of the referendum vote there certainly was a palpable sense of shock within most boardrooms. There was very little visibility as to what the UK Government had in mind in terms of strategic goals for Brexit and the negotiations and at the time of writing this was still the case. Nonetheless, Fidelio observes that post-referendum boards have responded with greater clarity and purpose than ahead of the vote.

One example of the shift in mind-set that Fidelio has observed is an increasing use of the board evaluation tool. Where previously evaluations may well have been box-ticking compliance exercises, in the months following the referendum we observed chairmen using external evaluations outside the mandated threeyear cycle to take stock, to identify what was known and what was not known within the board, the strengths, the weaknesses and the skills needed to navigate uncertainty.

As we move into 2017, with the benefit of six month’s post-referendum perspective, we are now able to analyse some of the www.ethicalboardroom.com

Brexit | Board Leadership BREXIT AND BOARD IMPACT What skills will be needed to deal with the referendum outcome?

implications for board composition. We have divided our analysis into two parts: (i) how the regulatory framework is likely to change and (ii) how we anticipate board composition will adapt to deal with the complexity created by Brexit.

Part 1: The regulatory impact

There is a certain irony that one of the key strands of the Brexit campaign was anti-regulation. In reality, it is very likely that the UK will not escape EU regulation quickly. Moreover, the post-referendum UK Government has also exhibited a clear appetite for regulation – in particular with regard to corporate governance and diversity. The overarching regulatory framework for UK boards is currently shaped at EU level. EU directives, such as MiFID, which regulates how corporates and investors engage is clearly relevant

for the chairman of a UK-listed board who is thinking about board composition.

Equally, the UK has an admired corporate governance framework, with its unitary board and ‘comply or explain’ approach to governance, which is distinctive from the governance structure within many EU member states. The UK Corporate Governance Code is derived from UK company law, particularly the 2006 Companies Act, and differs substantially from many other EU countries with their two-tier board systems and heavy reliance on legislation. Over the past 10 years, UK boards have shown a high degree of adaptability in terms of both governance and composition and while there may well be quite substantial regulatory fallout from Brexit, we are confident that the ‘UK plc’ boardroom has the potential to adapt. There is a clear opportunity for the UK to continue to hold a leading position in terms of corporate governance.

In the immediate aftermath of the referendum vote there certainly was a palpable sense of shock within most boardrooms. There was very little visibility as to what the UK Government had in mind in terms of strategic goals for Brexit www.ethicalboardroom.com

Moreover, many of the regulatory themes that will shape future board composition are common to Europe and the UK. The demand for greater accountability from corporate boards gathered pace after the financial crisis. Across Europe, there is pressure to ensure better corporate governance through increased, more effective, regulation.

Certainly, there was a clear anti-big business element in the Brexit referendum result.

Business was stunned when Theresa May talked of employee representation on the steps of No. 10; perhaps even more so when the Conservative party conference seemed to lurch toward a very hard Brexit, apparently favouring very severe restrictions on freedom of movement versus the interests of business. There is, however, more recent evidence of a rapprochement between government and business.

Regardless of Brexit, boards should expect ongoing scrutiny and one way of promoting accountability is via board composition.

This was evident in the Department for Business, Energy and Industrial Strategy’s Corporate Governance Reform Green Paper published shortly before Christmas 2016.

It set out suggestions to promote better governance, including giving shareholders a binding vote on executive pay and suggesting the extension of corporate governance regulations to large private companies.

Winter 2017 | Ethical Boardroom 97

Board Leadership | Brexit A major focus of the UK Government’s Green Paper is to strengthen the wider stakeholder voice – including that of employees at board level. It is perhaps an irony that the employee board representation, which has been mooted (although subsequently toned down) by the post-referendum pro-Brexit UK Government, emanates from Europe.

Germany, for example, has a highly developed governance structure of employee representation across its boardrooms.

Apart from stakeholder representation in the boardroom, we are also seeing a strong regulatory and government interest in promoting increasingly diverse boards. This pre-dates the referendum and we do not see this changing in the future. The initial work of the Davies’ Review (2010-15) to increase the representation of women on quoted boards has continued. The Hampton-Alexander Report (published November 2016) set a voluntary target of 33 per cent representation of women on FTSE 350 boards and,

socio-economic, sociological and neurological, comprising backgrounds, experience and personalities. There is a sense in which the Brexit vote has thrown all the cards in the air and an appropriate response at board level has to be increased board diversity.

Part 2: The board response

This leads to part two of our analysis – how boards respond to the Brexit vote, including in terms of board composition. One of the most distinctive features of the Brexit referendum result was that boards and the establishment at large did not see it coming. There is much evidence that chairmen and leading luminaries were confident of a Remain vote (and of a Clinton victory) and UK boards are as guilty as anybody else of being in their own echo chamber. Since the referendum, there has been much soul-searching at board level over why this major change was not anticipated.

The degree to which business had failed to connect with the broader public and

Boards previously placed much higher reliance on politicians to promote business interests and to negotiate on their behalf. The Brexit vote undermined this trust and business is undoubtedly exposed to the risk of poorly conducted negotiations. As a consequence, we expect boards to further build their regulatory competence and expertise and also, at a simpler level, ensure that boards incorporate different international perspectives and have genuine insight into countries that are important to their business interests.

Finally, uncertainty will inevitably be a feature of the business landscape for the years ahead. As such, boards will need to become comfortable with a much higher level of unpredictability and volatility. Strategy cannot be linear and both companies and investors will need to learn how best to operate with multiple options. Effective boards will be characterised by agility, flexibility and speed.

Again these are characteristics that will feature more prominently in board role specifications of the Brexit era.

Of course, deep sectoral expertise will remain critical for boards. Finance will continue to be a dominant boardroom language. Cyber expertise will still be demanded by investors and regulators. Beyond this we expect Brexit to be a force for further diversification of the boardroom, extending beyond gender and ethnicity to experience, perspective and aptitude. Boards will also have to become considerably more self-reliant in building relationships that matter and forming opinions that are independent, sound and potentially counter-intuitive.

Conclusions FRESH THINKING Post-referendum, effective boards will be characterised by agility, flexibility and speed

importantly, also extended targets to the executive level of the FTSE100; all to be achieved by 2020. Spurred by this context, sectors that have traditionally been lagging in terms of diversity have begun to set up their own initiatives, such as HM Treasury’s Women in Finance Charter and the asset management industry’s Diversity Project.

Nor is the drive to increase boardroom diversity limited to gender. The 2016 Parker Review has also set goals for greater ethnic diversity at senior levels of corporates. This includes the requirement for FTSE 100 boards to have at least one director of colour by 2021 and each FTSE 350 board to have at least one director of colour by 2024. Thinking on diversity is becoming – quite appropriately – multi-dimensional. At the launch of the aforementioned Diversity Project in the asset management industry, Andy Haldane, chief economist at the Bank of England, argued that a very important dimension to diversity which is often overlooked is much more subtle: 98 Ethical Boardroom | Winter 2017

anticipate popular sentiment was stark, as well as the extent to which in many cases, while boards had contingency plans in place, they were psychologically unprepared for Brexit. The perils of ‘group-think’ have seldom been clearer; and the board skill matrix is currently under very critical review.

One skill that was in short supply in many a boardroom was the ability to interpret the public mood and to connect with key stakeholders. And yet within these same organisations there were typically highly skilled corporate affairs directors with good relations to government and often a very good sense of the public mood.

Fidelio expects the skills of engaging more effectively with stakeholders to be in increasing demand in the boardroom.

Given the danger of living within the bubble in the UK (or in the US), we also expect to be see further premium placed on social media skills – including an understanding of how to navigate these channels of communication.

Brexit is clearly a pivotal point for UK boards.

There remains little visibility and potentially a long and tortuous negotiating cycle ahead.

Brexit is already driving change for boards, both in terms of the wider regulatory framework and how boards need to adapt to the new reality. There is huge opportunity for UK boards to get ahead of the curve and secure the ‘licence to operate’. This requires fresh thinking in terms of committing to building up a strong corporate culture, bringing international perspectives and new skills into the boardroom, as well as refreshing the board’s ability to engage with key stakeholders.

At a recent Fidelio board breakfast, Sir Simon Fraser, former Permanent Under-Secretary of the Foreign and Commonwealth Office in the UK, concluded that failure to anticipate the totally unexpected is frequently not due to lack of intelligence or knowledge. It is, instead, the failure of imagination that can represent the much bigger risk. Fidelio concurs that boards need to ensure they are not lacking imagination and that they have sufficient skills and diversity of perspectives around the top table to navigate uncertainty at this extraordinary and unprecedented time. www.ethicalboardroom.com

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Board Leadership | Gender Diversity

Questioning quotas Setting targets to create gender balanced boards has been shown to work in many countries and yet it still often offends our notion of meritocracy In the past five years, we have witnessed a huge turnaround in attitudes to gender balance in corporate leadership in the UK and across several countries. As in many other developed economies, women make up almost half of the UK workforce and the majority of university graduates.

In some subjects, such as law and medicine, this has been the case for more than 20 years. And yet, across industries and sectors, the number of women in leadership positions remains woefully small.

In the UK, we have been monitoring the proportion of women on boards in the top FTSE-listed companies since 1999. In the decade following, the figure rose slowly from seven per cent to 12.5 per cent, where it plateaued. Other countries, such as the USA and Canada, also witnessed a stagnation around 15 per cent, reflecting what psychologists called ‘homosocial reproduction’, the often unconscious desire to ‘hire in one’s own image’.

Experts often try to explain the lack of women’s progress at one of four levels: at a micro individual level (that individual women are somehow lacking in ability, behaviour, or motivation); group level (that it’s about group dynamics and being uncomfortable with difference); organisational level (that there are structural issues around the way that work works, which disadvantage certain groups); or macro societal level (that we struggle still to see women as leaders, which contradicts our preferred nurturing, communal social roles for women). The truth is, it’s all of these, a complex and multi-level problem, with no one quick-fix solution.

Before 2010, there were a number of ‘myths’ that were commonly trotted out.

The first, rather wishful, one was that we just needed to give it time and the situation would sort itself out. But a decade of longitudinal data had proved that this would not be the case, and that if one were to follow the trajectories, it would be

100 Ethical Boardroom | Winter 2017

Professor Ruth Sealy

Associate Professor in Organisation Studies at Exeter University Business School another 70 years before parity was reached.

The second myth, which I was told by many a chair or executive search consultant, was that suitably qualified and experienced women simply could not be found. Data provided by myself and colleagues, in the form of a list of more than 2,000 women in senior roles across listed companies, in 2009, disproved that one.

From 2007 onwards, many of the large professional service firms produced reports revealing the positive financial benefits both to organisations and national economies of having more women in the boardroom and senior management. Multiple academic papers also attempt to argue for or against better financial returns from having gender balanced boards. Frankly, these are now so abundant that you will find whatever it is that you want to hear. However, in 2015, a definitive meta-analysis (study of studies) of 140 academic articles, in arguably the top academic management journal, found a positive relationship between accounting returns and female representation and this relationship is stronger in countries with stronger shareholder protections – possibly because those boards are motivated to take account of the diversity of background, experience, values and knowledge that different board members bring. There is almost no relationship between female representation and market value and a negative one in countries with low gender parity. However, the authors find that there is a strong positive correlation between female representation on boards and a board’s two main responsibilities: monitoring and strategy involvement. Interesting that it appears there is this slight ‘Catch 22’, whereby companies only benefit from women on boards in countries with attitudes that are ready to receive them!

Utilising female talent enables fresh perspectives to be brought to boards, with often greater attention to governance and attendance. Other research suggests they may bring different values into the boardroom, more benevolence and less power orientation. By improving diversity of thought, for independence, so that views don’t go unchallenged, research tells us that decision-making is better, albeit harder to get to, with a broader range of perspectives on issues, such as company performance, strategy and risk.

But for this to happen, attitudes must change. Changing attitudes is incredibly challenging and so several countries have decided that to get a faster result they would try to change behaviours first and hope that attitudes follow. And so, it is that today 14 countries have some form of quota legislation on women on boards and a

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Gender Diversity | Board Leadership

GENDER BALANCE For change to be sustainable there must be a focus on the executive pipeline

further 16 have some corporate governance ‘comply-or-explain’ approach. In the UK, history and academic evidence showed that this situation would not change sufficiently through organic processes. In 2010, the coalition government commissioned a review into women on UK-listed boards. The review committee, headed by Lord Mervyn Davies, took a proactive, evidence-based, multi-stakeholder ‘voluntary business-led approach’ and set a stretch target of 25 per cent women on boards by 2015.

Amid outrage of ‘interference’ and ‘unachievable target’, the Davies report laid out 10 clear recommendations of actions for stakeholders, including search firms, chairmen, CEOs, investors and the Financial Reporting Council, and a trajectory of progression that would enable the target to be met. Having risen only five percentage points over the previous decade, from 2011 to 2015 it more than doubled from 12.5 per cent to 26 per cent. The target was achieved without the need to implement a quota.

Now the UK is considered a role model by other countries of how to achieve progress on this issue without using quotas. And yet, all the stakeholders involved agreed that such change would not have happened

without the threat (from both the EU and the coalition government) of further intervention. Businesses view quotas as a radical change agenda, often misconstrued, causing emotional rather than rational responses. But why do we believe that business acts rationally?

Organisations are only made up of humans and humans are guided by bounded rationality. If they were entirely rational we would not have market failure, which we clearly do, when so much female talent is under-utilised. Although different countries are using different models of quotas with varying sanctions, the one unifying characteristic is the conflicting rationales, logics and often ethical tensions that surface. But why should the idea of quotas provoke such an emotional, often vitriolic response? Along with a colleague, Professor Siri Terjesen, I have considered just this.1 We found three main areas of tension: the motivation for quotas; the legitimacy of quotas; and confusion around the outcomes of quotas.

Businesses view quotas as a radical change agenda, often misconstrued, causing emotional rather than rational responses www.ethicalboardroom.com

Motivation refers to the underlying rationale for quotas. Is it one of justice or utility? Interestingly, both arguments are used both by supporters and opponents.

Supporters argue for better use of female talent and justice for gender equality.

Opponents argue firms should be free to use whichever talent they wish and justice that any individual should be able to get a board position, regardless of gender. And are organisations motivated to change due to considerations of compliance or integrity?

Interestingly, and perhaps experienced by many UK boards recently, symbolic change (i.e. playing with the numbers) can often lead to more substantive, unintended cultural change. In addition, as in the UK, the threat of a quota is sometimes sufficient to effect change, but in other countries quotas without sanctions effect little change.

Winter 2017 | Ethical Boardroom 101

Board Leadership | Gender Diversity The question of quotas’ legitimacy often revolves around principals of ethicality and meritocracy. Quotas can symbolise both inequality and equality in a national context – how do we justify a policy that may want to prevent and compensate previous injustices, but uses discrimination? This is the dilemma of the shackled runner. If, after a race has started, you realise that one runner is in shackles, do you stop the race and simply remove the shackles and tell the runners to continue, or do you bring the previously shackled runner up to the same level as the unshackled runner before continuing the race? To be legitimate, quota interventions must be an accepted part of societal norms and values. But this may be a chicken and egg situation, requiring change to be introduced first and justified later. Otherwise if multiple stakeholders are responsible for the continued problems, it is not always clear who should legitimately be involved with ‘fixing’ it.

Quotas offend our belief in meritocracy, but all the data shows that we do not live in a meritocracy. Individual women often reject quotas as they don’t wish to be a ‘token’ and female candidates for directorships are often urged to have many additional qualifications, to prove their legitimacy, in a way not required of men. Yet we know from research that perceptions of female directors’ legitimacy shift once women comprise a critical mass – usually operationalised as three women directors on a board. The irony is that tokenism, and the negative group dynamics that follow, occurs when there is just one woman, or ‘different’ candidate, on a board.

When quotas are introduced, greater gender balance becomes the norm and women’s views are perceived as more legitimate, as those of just another individual. So, unless we really believe that men are better qualified for leadership, quotas become a rational, legitimate response to structural barriers, ensuring greater meritocratic outcomes.

The other big problem is that we struggle to define a successful outcome of a quota – whether to focus on short-term quantifiable metrics or longer-term somewhat more ambiguous measures of culture-change.

Another issue is the level of

measurement for the quota or target – for example, in the UK the 25 per cent target achieved was at an aggregate level across the FTSE 100, meaning that while some companies have 45 per cent female directors, others have less than 10 per cent. Different stakeholder groups are differentially affected by quotas and rarely agree on desired outcomes – for example, for shareholders, equity outcomes are inconclusive and causality directions unknown. However, most agree that post-quota/target boards have higher levels of functioning, leveraging new perspectives and more engaging discussion.

Quotas or targets have been successful in increasing the numbers of women on boards

Unless we really believe that men are better qualified for leadership, quotas become a rational, legitimate response to structural barriers, ensuring greater meritocratic outcomes in some countries (e.g. Norway, France, UK), but not so in others (e.g. Spain, Netherlands).

But there is some disquiet that the increase has only been in non-executive directorships (NED). Across much of Europe, boards operate a two-tier system and the quotas were only aimed at the supervisory board, so this outcome should not be a surprise. In the UK, we have a unitary board and while most of the gain thus far has been in NED roles, in 2015, after several years of stagnation at five to six per cent, the proportion of female executive directors finally began to rise to currently 10 per cent.

The goal of increasing executive directorships and developing the female talent pipeline through senior management is the remit of the next government-backed review.

The (Sir Philip) Hampton- (Dame Helen) Alexander Review has not only taken on the 33 per cent women on boards

target for all FTSE 350 companies, but also a target of 33 per cent for FTSE 100 executive committees and their direct reports, by 2020.

This is a bold target, but in essence follows many of the larger banks, professional service firms and other companies (such as Lloyds Bank, RBS, KPMG, PWC, BHP Billiton, GSK, Clifford Chance, Ashurst), who have led the way in publicly setting targets for themselves at levels below the board. This has been one of the greatest impacts of the Lord Davies Review – the acceptability of the use of measurable objectives to effect gender change.

So have our attitudes changed in the UK to women on boards? I would venture to say that they have, certainly within our largest organisations. It is now socially unacceptable as a large public organisation to have an all-male board. Ed Smith, Chair of NHS Improvement, has stated a gender target of ‘50:50 by 2020’ for NHS boards in England.

Polls in Europe show the public are strongly in favour of gender balanced boards: 88 per cent believe, given the same qualifications and skill, that women and men should have equal representation in leadership roles and the majority were in favour of some sort of legislation to enact this. Boards’ approaches to hiring have become more transparent and considered, diversity is becoming a part of the board-evaluation process, and boards pay attention to diverse succession planning.

However, recent research published in Harvard Business Review, after interviews with 60 male and female board directors from more than 300 publicly traded companies across the world, revealed that in countries that don’t have quotas or targets (such as the USA), the myths about the problem and the fears about possible solutions remain. By using, and achieving, measurable objectives for gender balanced boards, we may not eliminate gender bias but, over time, women directors and leaders will be viewed as business as usual. As a senior partner of one of the Big Four recently said, a focus on diversity may start with counting the numbers, but inclusion is about making the numbers count.

1 Terjesen & Sealy (2016), Board gender quotas: Exploring ethical tensions from a multi-theoretical perspective, Business Ethics Quarterly, 26(1), p. 23-65.

FOCUS ON DIVERSITY It is now socially unacceptable to have an all-male board 102 Ethical Boardroom | Winter 2017

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Global News Africa

Nigeria suspends governance code The Nigerian government has suspended the Corporate Governance Code issued by the Financial Reporting Council of Nigeria (FRC) and sacked the agency’s executive secretary Jim Obazee.

Obazee’s departure followed the controversial resignation of Enoch Adeboye as the overseer of the Redeemed Christian Church of God. The pastor had said he was stepping down in ‘compliance’ with the Code’s guidance for non-profit organisation, including civil society and religious organisations.

The Code stipulates that the founder or leader of a non-profit cannot stay in authority for more than 20 years or beyond the age of 70. According to the government, the Code will stay suspended, pending a review and consultation with stakeholders.

Tullow Oil unveils pending boardroom shakeup

Aidan Heavy, the CEO and founder of African oil and gas company Tullow Oil, is to step down in April and will become non-executive chairman.

Paul McDade, currently chief operating officer, will be appointed CEO following Heavy’s move at the annual general meeting on 26 April 2017. Heavy (right) will replace Simon Thompson, the current chairman, but has agreed to leave the role within two years. The boardroom shuffle follows an internal and external process led by Tullow’s nominations committee, the company said.

Zuma: ‘Give blacks a larger stake in business’ South Africa’s boardrooms and many top management positions are too white-male dominated and this “must change”, President Jacob Zuma has said.

Speaking at an African National Congress rally in Rustenburg, Zuma called on the private sector to change its policies faster and give South African blacks a larger stake in their business.

Zuma said: “The country needs a private sector that acts in the national interest and which contributes to the attainment of the national goals of eradicating poverty, unemployment and inequality.

“By excluding the majority of our people from ownership of the economy, by excluding them from the management of companies and from many professions, we are starving our economy of the human capital it needs to develop.”

104 Ethical Boardroom | Winter 2017

Israeli billionaire in Africa bribery scandal released

Investigations into a giant mining project in Guinea called Simandou — believed to be one of the world’s richest deposits of iron ore — led to the brief house arrest of one of the world’s richest men.

Israeli billionaire Beny Steinmetz was released without charge by Israeli police after being held under house arrest on bribery allegations connected with African mining rights.

Steinmetz is the owner of mining group BSG Resources — the company accused of bribing the Guinean former president’s wife to gain half the rights to Simandou. Asher Avidan, a top executive at BGSR, was also detained by the Israeli police. BSGR has described the bribery allegations as “baseless”.

Goodluck Jonathan denies receiving any oil deal kickbacks

Nigeria’s former president has denied allegations that he and his oil minister received kickbacks as part of a $1.3billion deal with Italian oil company ENI and Royal Dutch Shell.

Goodluck Jonathan (above) has also denied that his government was corrupt and contested his successor Muhammadu Buhari’s claim that he inherited a “virtually empty” treasury.

A statement issued by Jonathan’s spokesman, Ikechukwu Eze, said: “We will like to point out for the umpteenth time that whether in office or out of office, former President Jonathan does not own any bank account, aircraft or real estate outside Nigeria.” www.ethicalboardroom.com

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Africa | Corporate Governance

Improving business behaviour in Africa

Establishing coherent guidelines for corporate governance is becoming a priority if the continent is to maximise investment and realise its full potential Africa will host seven of the top 10 fastest growing economies in the world in the next five years, according to the International Monetary Fund. In countries, such as Côte d’Ivoire, Kenya, Rwanda, Senegal and Tanzania, ongoing investment in infrastructure and strong consumption are expected to drive growth at rates of six to seven per cent or more.

So it has become imperative to come up with initiatives that guide the formulation of Africa-specific guidelines to economic and corporate governance that champion the business dynamics of the continent and align to global standards.

With the current focus on growth and development in Africa, good corporate governance and capacity building in this area is vitally important; greater transparency and accountability will lead to increased interest in investment and economic development in Africa.

Effective implementation of corporate governance is not merely a compliance issue, but should be embedded in corporate culture.

Good corporate governance does have a wider impact, documented by research, because it: n Encourages investment n Enhances investor confidence and interest while lowering cost of capital n Boosts companies’ competitiveness n Better equips companies to survive economic crises n Makes corruption less likely n Ensures fairness to shareholders 106 Ethical Boardroom | Winter 2017

Monica Dowie

Programme Manager of the African Corporate Governance Network at the NEPAD Business Foundation n Forms part of the overall checks and balances on business that ultimately benefit society Africa clearly has diverse corporate governance systems and practices across the continent owing in large part to varying historic customs and origins (French, Portuguese and English), rich cultural heritage, natural resources (oil, minerals and gases) and geography.

Corporate governance needs to be improved in Africa through developing mechanisms and strategies unique to the African landscape.

This does not mean different standards of corporate governance apply to Africa, but that some characteristics exist which include a large number of state-owned enterprises (SOEs) and SMEs, a culture of corruption or pursuit of easy wealth, weak nature of the business environment and low financial intermediation.

The level of development of country-level corporate governance frameworks and their implementation is largely dependent on the level of political development and governance; economic development and governance; strength of regulatory institutions; and private sector and capital market development.

Challenges to face

Africa has not escaped the adverse effects of the global economic crisis, mostly due to the prevalence and importance of international trade, foreign capital inflows, development assistance and diaspora contributions to national economies.

A lack of confidence in African institutions and poor corporate structures have been

among the major reasons why many investors have tended to shy away from investing in the continent. There are a number of challenges facing corporate governance reform in Africa that include: n Diversity – Africa consists of 54 individual countries n Corruption n Regulatory issues with varying levels of strength of regulatory bodies n Inactive shareholders n State-owned enterprises differing in size, market share and number n Board weakness n One-size-fits-all governance codes n Political instability n Lack of institutional capacity The best to way to address these reform challenges is to have sustainable and legitimate institutes of directors and corporate governance, sound capacity building initiatives of those charged with corporate governance, focussed and relevant research that is easily accessible and continued lobbying for improved corporate governance.

Corporate governance on the African continent is moving forward and there are a number of examples of progress and innovation in developing appropriate governance models for Africa. However, for a host of reasons, Africa still needs to lift its investment in corporate governance.

A number of measures implemented to improve corporate governance across the continent include: n Corporate governance codes, such as the King Reports in South Africa n Amendment of legislation to ease business registration and improve corporate reporting www.ethicalboardroom.com

Corporate Governance | Africa

A lack of confidence in African institutions and poor corporate structures have been among the major reasons why many investors have tended to shy away from investing in the continent

n Legislation that targets economic and financial crimes e.g. anti-bribery and money laundering n Strengthening of banking and financial regulation and supervision n Entrepreneurial and SME development n Increasing the pool of qualified directors through training programmes n Widening the representation of women on boards n Implementing measures to improve the efficiency of SOEs, including divestiture of state interest and corporatisation

Deepening governance

On a continental level, the African Peer Review Mechanism (APRM) was initiated in 2002 and established in 2003 by the African Union in the framework of the implementation of the New Partnership for Africa’s Development (NEPAD). The APRM is a voluntary self-assessment tool instituted

by African heads of state and was designed to promote more effective governance across the four thematic areas of democracy and political governance, corporate governance, economic governance and management, and socio-economic development.

The primary purpose of the APRM is to foster adoption of policies, standards and practices that lead to political stability, high economic growth, sustainable development and accelerated economic integration, in line with the NEPAD strategic framework goals.

The specific aim of the APRM corporate governance pillar, is to align as much as possible the interests of individuals, corporations and society within a framework of sound governance and common good.

The World Bank’s Country Assessments of Observance of Standards and Codes and the associated reports (ROSCs) also have a www.ethicalboardroom.com

significant influence on country-level development of corporate governance and act as an important tool for influencing policy development at a national level.

The African Corporate Governance Network (ACGN) which was launched in October 2013, currently represents 19 African countries and is a network of institutes of directors and corporate governance, including affiliate members committed to good economic and corporate governance.

The ACGN was formed to develop institutional member capacity for enhancing effective corporate governance practices, building better organisations and corporate citizens in Africa, and seeks to provide policy makers and market participants with an important forum to exchange experiences and best practices aimed at addressing ongoing corporate governance challenges in Africa.

In February 2016, the ACGN launched a report with the support of EY, on the State of Corporate Governance in 13 African countries. Some key conclusions drawn and lessons learned can inform future corporate governance reform work in Africa: n The designing of corporate governance programmes and frameworks should take into account the diversity of the continent n Greater emphasis should be given to small and medium-sized enterprise

n

n

n

n

and other forms of enterprise in those countries with relatively small capital markets n Good corporate governance principles and ethical leadership should be equally applicable to both the public sector, private sector and civil society A conducive policy environment is essential, with a reciprocal focus on enhancing or supporting governance processes and structure at a government level There is a need for more public-private sector consultation for effective reform to bridge the link between corporate governance and wider macro and systemic governance The responsibility for promoting good governance practices should be a collaborative effort between board directors, management, policy makers, regulators and market participants Adequate sensitisation and capacity building programmes are required to support the role of civil society

In order to achieve the goals and objectives of the African Union’s Agenda 2063, which is a 50-year plan towards Africa’s development, growth and prosperity to eradicate poverty, proper governance structures must be in place to succeed in attaining the ‘Africa we want’.

Going forward, Africa’s potential and ability to maintain current growth trajectories and high investor confidence, is going to hinge on good corporate, political and economic governance.

It is therefore the responsibility of both public and private sector role players to cooperate in efforts to change the perception that corporate governance is a ‘soft issue’ and to work together to ensure that good governance is a priority, if the long-term sustainability of Africa’s development is to be realised.

Winter 2017 | Ethical Boardroom 107

Africa | Ethics ETHICAL BEHAVIOUR Taking action now will position companies well for the future

Ensuring corporate integrity Four practical ways for African companies to boost their ethical profile In the run-up to the April 2017 implementation of the King IV Code on Corporate Governance for South Africa, thereâ&#x20AC;&#x2122;s lots of talk about what it all means. From my perspective and experience working with companies, regulators and governments alike on ways to improve corporate governance, it all boils down 108 Ethical Boardroom | Winter 2017

Roman Zyla

Regional Lead, Africa Corporate Governance Program, in the Transactional Risk Solutions Department, Environment, Social and Governance, at IFC

to a change in one little word.

But with this change comes big implications for companies.

The King IV Code requires listed companies to both apply the financial rules AND to explain the non-financial aspects of company operations. It replaces the King III Code requirement that companies either

apply the financial reporting rules OR explain the reasons they are not.

The revised code obligates companies to go beyond boilerplate reporting about their financial status to reveal more about their operational context.

The implication is clear: South African companies need to get better fast in their approach to transparency and disclosure. www.ethicalboardroom.com

Ethics | Africa But I would argue that it’s not just an issue for South African companies. In Kenya, for example, IFC is advising the Capital Market Authority on implementing a new corporate governance code. The code places great emphasis on transparency and disclosure, with a particular focus on stakeholder relations, ethics and corporate responsibility.

Globally, there’s a strong push for more detailed reporting on non-financial aspects of company operations, led by investors and shareholders. The reason? An increased level of disclosure, going beyond the balance sheet to span all aspects of operations, makes it harder to cover up ethics breaches, poor corporate citizenship, or otherwise bad corporate behaviour. Best-in-class disclosure gives investors comfort. It can mitigate some of the risks inherent in emerging and frontier markets, where there could be weak institutional oversight.

For companies in emerging markets, this better disclosure – including detail on safeguards to reduce the risk of ethics troubles – can be a differentiator as they compete for foreign investment.

In addition, some studies have shown that increased disclosure and more detailed reporting can help lower companies’ cost of capital.

At IFC, our own commitment to heightened transparency and disclosure is embedded in our access to information policy. For our clients, we are responding to the growing global emphasis on transparency and disclosure with new tools that help companies enhance their non-financial reporting. We are also are expanding the scope of our corporate governance advice, which falls within a comprehensive environmental, social and governance framework to address the broader range of ethical issues companies face in today’s complex world. It’s all part of our overarching mission to encourage investment in emerging markets, guided by performance standards that aim for a strong triple bottom line: solutions that are good for business, investors and the local community and environment.

Unfortunately, though, there will always be bad actors.

There will always be those in corporate positions of power with criminal intent in mind.

There will always be the potential for ethical lapses – even if they are inadvertent or unintended.

That’s not to say that nothing can be done.

Companies can take strong www.ethicalboardroom.com

and decisive action to reduce these risks.

They can demonstrate proactive efforts to safeguard their corporate integrity. In doing so, they will be better positioned to attract investment and thrive over the long term.

Here are four steps African companies can take right now to ensure that their ethical houses are in order.

Four steps to ensure an ethical operational environment

1

Remember your stakeholders The arbiters of a company’s ethical behaviour are its wide range of stakeholders.

These include employees, who may not have a say in how the company is run.

However, even a perception of impropriety – and the ensuing damage to the company’s reputation – could have a profound impact on them and their families.

Customers, too, play an important role.

They can validate the company’s integrity by purchasing its products and services. In the event of inappropriate company behaviour, they can show their dissatisfaction by buying the competitor’s goods instead, with potentially disastrous revenue implications for the company.

An increased level of disclosure, going beyond the balance sheet to span all aspects of operations, makes it harder to cover up ethics breaches, poor corporate citizenship, or otherwise bad corporate behaviour The community at large also has a vested interest in the company, which has the potential to drive broader economic growth in the region. The community has power as well, bringing to bear a collective voice that is louder and stronger than ever, thanks to social media.

Companies that behave badly – say by sending untreated manufacturing waste into local waterways or by making false claims about its products – won’t go unnoticed for very long.

A failure to attend to stakeholders and what they care about means putting the company’s reputation and very survival at risk. Putting in place formal stakeholder engagement policies, strategies and procedures can mitigate this risk. a diversified, strong and 2 Build independent board of directors

Much of the responsibility for ethical corporate behaviour lies with the company’s board of directors. The converse is true as well: a weak board is an open invitation for bad actors to perpetrate fraud or other criminal activity.

In short, the board is the custodian of the company’s reputation – for better or for worse.

For this reason, a strong board, comprised of a gender-diverse mix of directors, who bring complementary skills and experience to the

table, is a must. Independent directors with standing in the community or in their field are an important part of the mix.

They bring objectivity and an outsider’s point of view along with their good reputations, which can only benefit the board’s discussions and decision-making. fraud prevention 3 Formalise and safeguarding protocols

The conversation in African boardrooms today should be about putting into place robust safeguards to reduce the risk of ethical breaches.

It starts with a clear statement from the board, indicating that the company has zero tolerance for fraud. The statement should include a plan for the what-if: what if evidence of fraud comes to light? It should stipulate the importance of the board’s role in stepping up, pushing for an investigation and announcing the results.

After defining the systems and processes that would guide an investigation, the company can test out the approach through frequent simulations. This will ensure that the anti-fraud mechanisms that were put in place remain relevant and effective. Such exercises demonstrate vigilance, putting potential fraudsters on notice that they will not be able to get away with their actions. conflicts of interest and 4 Address minimise related party transactions

Conflicts of interest are bound to happen.

The reality in many of Africa’s smaller markets – where there may be a limited number of suppliers and an even more limited number of players – is that it is next to impossible to avoid such conflicts. It could be a related party transaction, for example in a situation in which a board director has a connection with a potential supplier. This can result in unfair market practices, such as preferential pricing or too favourable a deal in exchange for a non-compete contract.

If such conflicts can be avoided, they should be. But, in accepting the reality on the ground, the key is to establish a clear policy that defines how the company handles such conflicts when they arise. The policy should state that anyone who has a conflict of interest should disclose the conflict.

They should step away from the situation at hand and recuse themselves from the discussion and the decision.

Of course, it’s not enough to have a policy on paper. It needs to be enforced. And, it needs to reported, rather than pretending it never happened.

Taking such actions now will position African companies well for the future.

They will be better prepared to respond appropriately. And they will show that they have done all they can to reduce their business, ethics, governance and reputational risks, as the call for enhanced transparency and disclosure grows louder.

Winter 2017 | Ethical Boardroom 109

Corporate Governance Awards | Introduction

Ethical Boardroom Europe & Africa award winners 2017 Today’s corporate leaders must not only deliver operational excellence and winning strategy, but have strong ethical and professional values, and a commitment to good corporate governance.

The new King IV Report on Corporate Governance, issued by the Institute of Directors in Southern Africa (IoDSA), brings the role of ethical and effective leadership to the fore. According to this latest version of the King code – released in November – while leadership starts with each individual director, it finds its expression through the board as a collective, setting the appropriate example and tone.

King IV explains the governance of ethics as the role of the board in ensuring that the ethical culture within the organisation is aligned to the tone set by the board through the implementation of appropriate policies and practices.

Other important issues covered by King IV include the wage gap, shareholders voting on remuneration policies and their implementation so as to trigger engagement with the company and the composition of the governing body.

King IV now proposes that companies establish a clear link between performance and remuneration; it will be necessary for the remuneration committee to consult with the social and ethics committee when a determination is made on the fairness and reasonableness of executive remuneration.

The issue of shareholders voting on remuneration policies has also come under focus in the UK, with BlackRock – the world’s largest asset manager – threatening to unleash a wave of shareholder rebellions in the UK unless Britain’s largest companies rein in excessive boardroom pay.

Total pay for bosses of FTSE 100 companies has quadrupled over the past 18 years as

repeated efforts by shareholders to control escalating remuneration awards have failed.

BlackRock’s tougher stance on executive pay is detailed in a letter sent to the chairmen of more than 300 companies in the UK. In it, BlackRock says it considers misalignment of pay with performance as an indication of insufficient board oversight, which calls into question the quality of the board, and that it believes that shareholders should hold directors to a high standard in this regard.

Executive pay should be strongly linked to performance, meaning strong and sustainable returns over the long-term, as opposed to short-term hikes in share prices.

The Ethical Boardroom Corporate Governance Awards recognise and reward outstanding companies who have exhibited exceptional leadership in the area of governance. The awards highlight the important role that corporate governance plays in dictating a company’s success and a board’s contribution to the creation of long-term value.

Ethical Boardroom is proud to announce its Corporate Governance Awards Winners in Europe and Africa.

While leadership starts with each individual director, it finds its expression through the board as a collective, setting the appropriate example and tone

110 Ethical Boardroom | Winter 2017

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AWARDS

The Winners | Corporate Governance Awards

WINNERS 2017

EUROPE&AFRICA

EUROPE RETAIL: NEXT PLC FINANCIAL SERVICES: ING GROUP N.V. MINING: BHP BILLITON PLC OIL & GAS: ROYAL DUTCH SHELL PLC UTILITIES: RED ELÃ&#x2030;CTRICA CORPORACION S.A PHARMACEUTICALS: NOVO NORDISK A/S FOOD & BEVERAGE: DIAGEO PLC CONGLOMERATE: UNILEVER PLC TELECOMS: TELECOM ITALIA GROUP AUTOMOTIVE: DAIMLER AG LEISURE & ENTERTAINMENT: MERLIN ENTERTAINMENT PLC CONSTRUCTION: VINCI S.A. AFRICA FINANCIAL SERVICES: GUARANTY TRUST BANK PLC TELECOMS: VODACOM GROUP LIMITED PHARMACEUTICALS: ASPEN PHARMACARE HOLDINGS OIL & GAS: OANDO PLC MINING: KUMBA IRON ORE LIMITED CONGLOMERATE: THE BIDVEST GROUP LIMITED MEDIA: NASPERS LIMITED INSURANCE: LIBERTY GROUP LIMITED

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Winter 2017 | Ethical Boardroom 111

Corporate Governance Awards | Vodacom

AWARDS WINNER 2017 AFRICA TELECOMS

The Vodacom way Vodacom Group is a 22-year-old company that has always subscribed to the highest standards of social responsibility and ethics across all its operating territories.

We assess our performance against various mandatory and voluntary standards. The standing commitment good corporate governance, business integrity and ethics are key ingredients to our sustainability.

Who are Vodacom?

We are a leading African mobile communication company providing a wide range of communication services, including mobile voice, messaging, data and converged services to more than 61 million customers.

From our roots in South Africa, we have grown our mobile network business to include operations in Tanzania, the DRC, Mozambique and Lesotho. Our mobile networks cover a total population of approximately 200 million people.

Through Vodacom Business Africa (VBA), we also offer business managed services to enterprises in 30 countries across the continent.

Vodacom is majority owned by Vodafone (65 per cent holding), one of the worldâ&#x20AC;&#x2122;s largest communications companies by revenue.

Vodacom is a listed company on the Johannesburg Stock Exchange (JSE) and 112 Ethical Boardroom | Winter 2017

A company where good corporate, social responsibility and ethics are central to our sustainability Tshepo Ramodibe

Executive Head of Department: Corporate Affairs, Vodacom Group manages and measures its performance with reference to the principles set out in the King report on corporate governance in South Africa 2009 (King III), the Companies Act and expectations of the FTSE Russell.

The commitment to good corporate governance has been a constant feature since our listing on the JSE in 2009. The latest recognition by the Ethical Boardroom Corporate Governance Awards, the second in as many years, reflects an appreciation of governance, the central role of our board in exercising leadership and sound judgement in directing Vodacom to achieve sustainable growth and acting in the best interests of all our stakeholders.

A framework for sustainable development

Operating responsibly is essential to our licence to operate and delivers commercial

advantages to our business, helping to turn potential risks into opportunities.

By acting with honesty and integrity we can secure the trust of our customers, which is integral to the long-term success of our business.

We sustain our ability to create value for all our stakeholders through maintaining robust ethics, governance and risk management processes and structures.

The board takes overall responsibility for Vodacomâ&#x20AC;&#x2122;s success. Its role is to exercise leadership and sound judgement in directing Vodacom to achieve sustainable growth and act in the best interests of all our stakeholders.

Corporate governance structure

Our governance structure, comprising the board, related committees and the executive committee plays an integral role in supporting our business operations and realising our purpose, vision and strategies.

Board leadership and committees

Board: Vodacom has a unitary board of 12 directors, of whom five (including the chairman) are independent non-executive directors, five are non-executive (but not independent as they represent Vodafone) and two are executive directors. Although King III recommends that more than half of nonexecutive directors are independent, the board is satisfied that the balance of power and www.ethicalboardroom.com

Vodacom | Corporate Governance Awards ENTERPRISE MOBILITY Vodacom offers business services to enterprises in more than 30 countries

VODACOM GROUP BOARD RESPONSIBILITIES The board charter details the responsibilities of the board, which include:

Oversight of the Group’s strategic direction

CONNECTING PEOPLE The company provides mobile services to more than 63 million customers

Approving major capital projects, acquisitions or divestments

Exercising objective judgement on the group’s business affairs, independent of management

Ensuring the appropriate governance structures, policies and procedures are in place

Ensuring the effectiveness of the group’s internal controls

Reviewing and evaluating the group’s risks

Approving the annual budget and operating plan

Approving the annual and interim financial results and shareholder communications

Approving the senior management structure, responsibilities and succession plans

Technology governance

VODACOM GROUP GOVERNANCE STRUCTURE

CEO

BOARD

Executive committees

Executive committees

● ● ● ● ●

● ● ● ● ● ● ● ● ● ● ●

Nomination committee Remuneration committee Social & ethics committee Executive committee Audit, risk & compliance committee

objectivity on the board is sufficient and does not require additional independent voices.

Accountability: The board takes overall responsibility for Vodacom’s success. Its role is to exercise leadership and sound judgement in directing Vodacom to achieve sustainable growth and act in the best interests of shareholders. In line with best practice, the roles of chairman and chief executive officer are separate. The chairman is responsible for leading the board, while the chief executive officer is responsible for the operational management of the group.

Business integrity

The reputation of our business and value of our brand is built on Vodacom’s long-standing commitment to being a responsible, transparent and ethical business, and securing and maintaining the trust of our diverse stakeholders.

The King III principles set out the ethical commitments and performance requirements that lay the foundation for a socially responsible and truly profitable business. As a Vodafone subsidiary, we have adopted the Vodafone Way, Vodafone Business Principles and the Vodafone Code of Conduct and made them relevant to our own market conditions, managing and measuring our performance accordingly.

To meet our high standards, we create a culture where employees understand what we www.ethicalboardroom.com

require of them, recognise their responsibility to raise concerns and have the confidence to do so. Our anti-bribery programme, supported by training and monitoring, is a particular focus.

Promoting ethical conduct

Our code of conduct (Code), supported by our 10 underlying business principles, explains what is expected of everyone working for and with Vodacom, including employees, contractors and suppliers. It also sets out Vodacom’s responsibilities to our people, partners and shareholders. The Code is underpinned by an extensive and well-established framework of policies and systems to manage our responsibilities. This year, we reviewed our Code to ensure its relevance to current business conditions and we have made the process of understanding the Code easier through videos and case studies.

Code of conduct

The Vodacom code of conduct sets out 11 business principles that provide a reference for ethical behaviour in the group:

1

Complying with all relevant laws, standards and principles

Finance International business Technology Enterprise Consumer Customer operations Corporate affairs Legal & regulatory Human resources Strategy & new business Sales and distribution

business decisions on economic, 2 Basing social and environmental criteria and

maintaining financial integrity Voicing our opinions on industry issues while taking an apolitical stance Communicating openly with stakeholders while maintaining commercial confidentiality Valuing our customers’ trust and safeguarding their personal information.

Basing employee relationships on respect for individuals and their human rights Protecting the environment and improving the environmental and social benefits of products and services Building trust within communities and investing in social enhancement Protecting the health and safety of our customers, employees, partners and communities Acting with honesty, integrity and fairness in all our dealings Ensuring adherence to the Vodacom Way and code of conduct

3 4 5 6 7

8 9

10 11

Wherever we operate, we work to ensure that we do not infringe human rights through our operations or business relationships.

Winter 2017 | Ethical Boardroom 113

Corporate Governance Awards | Aspen Holdings HEALTHCARE LEADER Aspen manufactures and supplies a broad range of medicines and products that are distributed to more than 150 countries

AWARDS

WINNER 2017AFRICA

PHARMACEUTICALS

Aspen aspires to excellence Aspen Pharmacare has a proud heritage, dating back more than 160 years, and is committed to sustaining life and promoting healthcare through increasing access to its high-quality affordable medicines and products. With a market capitalisation of approximately $10billion, it is the largest pharmaceutical company listed on the Johannesburg Stock Exchange (JSE) and ranks among the top 20 listed companies on this exchange.

As a leading multinational company, it is imperative that Aspen’s ongoing application of international corporate governance best practice is achieved while maintaining its entrepreneurial approach to doing business.

Governance in the group extends beyond mere legislative and regulatory compliance and management strives to entrench an enterprise-wide culture of good governance aimed at ensuring 114 Ethical Boardroom | Winter 2017

Africa’s largest pharmaceutical company is committed to ongoing improvement of corporate practices

Riaan Verster

Company Secretary & Group Governance Officer, Aspen that decisions are taken in a fair and transparent manner, within an ethical framework that promotes the responsible consideration of all stakeholders, while also holding decision-makers appropriately accountable. In line with the philosophy that good corporate governance is an evolving discipline, governance structures, practices and processes are actively monitored and revised from time to time to reflect best practice.

Focus on ESG

Below are just some of the environmental, social and governance (ESG) highlights for Aspen during its 2016 financial year:

■ Aspen remains a contributing participant to the UN Global Compact and is committed to the application of the Compact’s principles in all of its business activities ■ There has been ongoing emphasis on embedding the group’s values and the application of the group’s code of conduct across all operations ■ An independent assessment of the group’s ethics management programme undertaken by the Ethics Institute of South Africa confirmed that this programme was effective in all material respects ■ Aspen has been included as a constituent on the JSE/FTSE Responsible Investment Index following its listing on the former Socially Responsible Index of the JSE for five consecutive years ■ An extensive project has been initiated to address the reporting requirements stemming from the Organisation for Economic Cooperation and Development’s base erosion and profit shifting project ■ Aspen participates in the Carbon Disclosure Project and Water Disclosure Project and has expanded the scope of disclosure, achieving improved scores. www.ethicalboardroom.com

QUALITY CONTROL Microbiologists ensure that all products are tested for sterility PORT ELIZABETH Aspen’s flagship manufacturing site in South Africa

MANUFACTURING CENTRES Aspen also produces tablets, capsules and liquids

in corporate governance Progress has been made in the development of appropriate activity-based intensity measures for the measurement of energy and water usage and projects to improve resource efficiency and/or reduce environmental impacts have been implemented

Implementing King IV Code

The coming into effect of the South African King IV Code on 1 November 2016 has required Aspen to have a ‘blank page’ reconsideration of its governance systems, practices and procedures – Aspen welcomed the introduction of this Code and has been an early adopter of many of the recommended practices contained in King IV and aims to formalise the application of all 17 principles prior to the commencement of its next financial year. Where King III required organisations to apply certain principles or explain why it had not, King IV follows an outcomes-based approach, requiring entities

to demonstrate qualitative application of good corporate governance.

In this regards it requires an ‘apply and explain’ approach in terms whereof it assumes application of 17 principles and strives to instil a qualitative approach and, to avoid mindless compliance, a quantitative approach.

Organisations should explain the practices that have been implemented to give effect to each principle and to realise the specific governance outcomes, namely ethical culture, good performance, effective control and legitimacy. Explaining the application of King IV will allow stakeholders to make an informed assessment as to whether an organisation is indeed achieving the four governance outcomes.

History has repeatedly shown that quantative reporting does not necessarily translate into quality of corporate governance.

Organisations that mindfully implement practices that give effect to King IV’s

Governance in the group extends beyond mere legislative and regulatory compliance and management strives to entrench an enterprise-wide culture of good governance www.ethicalboardroom.com

principles will benefit from achieving the four stated governance outcomes, namely an ethical culture, good performance, effective control and legitimacy.

King IV has a clear focus on transparency and recommends specific disclosures, among others in relation to executive remuneration, risk governance, ethics governance, information and technology, compliance and stakeholder governance.

Modern commerce implies that information is at the fingertips of society at large – as a result, ethical governance is not just expected but demanded of everybody who fulfils a leadership position. Many commentators have heralded King IV as an invaluable guide to leaders on how to govern ethically. In the current political, economic and social climate this report is to be embraced unconditionally and encouraged completely. Other ESG areas of focus for Aspen in 2017 will be: ■ Ongoing emphasis on ensuring an ethical and values-driven culture throughout the company ■ The development of appropriate activity-based intensity measures and continued focus on resource conservation across its operations Winter 2017 | Ethical Boardroom 115

Regulatory & Compliance | Bribery

Anti-bribery compliance in a changing world Global indicators and how the TRACE Matrix can help you assess the health of particular regions and markets Corruption, however you define it, has been with us from the beginning of human society. And for just as long, it has been the object of struggle and resistance.

Prophets have railed against it; philosophers have denounced it; and people in every age have endured and chronicled the suffering it causes.

Yet the anti-corruption movement, in the form we currently know it, is relatively young.

It has its roots in a specific post-war global economic order, made possible by technological developments and transnational political institutions. It grew from those roots after the Watergate-era exposure of widespread foreign bribery within that global order. And its branches take a variety of forms, from national agencies to international NGOs, from citizen activists to corporate compliance departments.

As stewards and overseers of their organisations’ economic activities, corporate directors are uniquely positioned to align those activities with the highest ideals of governance and trade. Those ideals, and the institutions that promote them, provide a framework of stability, predictability, and transparency that allows free markets to thrive. The corruption of those ideals by kleptocrats and their accomplices undermines stability, gives rise to uncertainty, and fosters suspicion through darkness and distraction. It breeds chaos and corrodes trust, to the detriment of all.

Addressing the uncertainty of business-bribery risk

To engage effectively and responsibly in international trade, companies need to take advantage of stability and trust where they can, and gird themselves against corruption and chaos where they must. A critical part of that effort is obtaining reliable information about 116 Ethical Boardroom | Winter 2017

Robert Clark

Manager of Legal Research, TRACE International the relevant conditions in each market. With respect to the issue of public-sector bribery, TRACE International (in collaboration with the RAND Corporation) has developed a tool to help with that effort. That tool – the TRACE Matrix – models the conditions that make bribery demands more or less likely in 199 countries.

The Matrix risk model is composed of four interlocking ‘domains,’ each including a number of specific factors that may contribute to bribery risk.

First are the factors directly affecting companies’ engagement with public officials: ■ The amount of government contact typically required in conducting business ■ The degree to which bribes are considered a normal part of the process ■ The extent of business regulation The second group of factors gauges the government’s own efforts to rein in corruption: ■ The extent to which bribery is legally proscribed ■ The effectiveness with which those proscriptions are enforced The third domain concerns transparency: ■ The extent to which information is publicly available about legislative and executive processes ■ The amount of financial disclosure required of government officials and civil servants Finally, we have the factors that measure the public’s ability to make use of such transparency: ■ Freedom of the press ■ The strength of civic institutions How are these factors measured? For this, we rely on research performed by organisations devoted to supporting the

ideals of good governance worldwide: foundational institutions, such as the United Nations and the World Bank; public-private associations, including the World Economic Forum and the International Budget Partnership; and issue-specific NGOs, such as Freedom House, Reporters Without Borders, and Global Integrity.

For example, the first factor – contact with government – in the first domain (business interactions with government) is calculated based on six country-specific indicators: ■ The percentage of the labour force employed by government ■ The number of visits or required meetings with tax officials ■ The number of official procedures required to register property www.ethicalboardroom.com

Bribery | Regulatory & Compliance

ASSESSMENT OF COUNTRY RISK The TRACE Matrix measures bribery risk in 199 countries

■ The number of procedures required to build a warehouse ■ The number of procedures required to enforce a contract ■ The number of procedures required to register a business These indicators are taken from datasets produced and made publicly available by the International Labor Organisation (at its ILOSTAT webpage) and by the World Bank (from its Enterprise Surveys and its Ease of Doing Business reports). Taken together, they provide a reasonable proxy for the amount of interaction with government officials one can expect to encounter when doing business in a country – and thus the number of hands potentially reaching out for an illicit payment.

The other domains and subdomains are www.ethicalboardroom.com

Corruption works by defying and attacking the elements and ideals of order. Given sufficient latitude, it can display an agility and a ferocity unrestrained by legal, ethical, or institutional norms similarly aggregated to provide standardised, objective numeric scores for each country.

Interpreting the results

It’s worth emphasising what these scores mean. They are intended to represent a set of interlocking societal conditions that either help keep corruption in check or encourage bribery to thrive: opportunity, expectation, and leverage; the threat of legal sanction; the ease with which illicit transactions can be kept hidden; the power of sectors outside the government to demand accountability. These factors can either promote or defy the ideals of regularity, predictability, transparency, and

stability on which a well-functioning market economy is based.

These ideals, undergirding a healthy global economy, didn’t arise spontaneously.

They have been advocated and sustained for the better part of a century by a particular set of institutions, established to promote a global order in which trade and development can be undertaken peacefully and effectively. It is those very institutions that, as an explicit part of their mission, have devoted significant time and resources to measuring and reporting the country-specific conditions that affect the strength and resilience of those ideals.

Winter 2017 | Ethical Boardroom 117

Regulatory & Compliance | Bribery One characteristic of large institutions is that they move slowly. This can be a strength – in some ways it embodies the ideals of stability and predictability on which good governance depends. But a certain nimbleness is lost. This has implications for an aggregate index, such as the Matrix. Most of the indicators from which the Matrix scores are calculated are updated at most once a year – not surprising, given both the direct costs of research and the institutional costs of defining the research’s direction, scope, and methods.

In addition, some countries are simply harder to obtain reliable information about than others, requiring the careful use of statistical ‘gap-filling’ techniques as part of the Matrix’s computational analysis.

All of this means that the Matrix should not be thought of primarily as referring to a particular moment in time. One might think of it as more a portrait than a snapshot.

It aims to convey a nuanced and meaningful image of bribery-related conditions throughout the world; it is not meant to capture short-term fluctuations or track minute differences within a given country from one iteration to the next. TRACE’s biennial production of a new edition of the Matrix is, in effect, a recalibration that is designed to ensure ongoing fidelity to the relevant business-bribery risk conditions, rather than a staging of the anticorruption equivalent of an international horse race.

Of course, countries do sometimes undergo rapid and dramatic changes – for better or for worse – in their corruption environments.

And these sorts of changes do in fact find themselves reflected in the Matrix calculations.

For example, in the 2014 Matrix, Estonia was deemed to be in fairly good health, presenting a low overall public-sector bribery risk of 33 out of 100. The reasons for that assessment were reflected in the country’s individual domain scores, with the low risk levels associated with minimal governmental interactions (20) and civil-society oversight (26) offset by significantly higher risk levels in connection with government transparency (39) and anti-bribery law and enforcement (58).

Overall, these scores were good enough to place Estonia just below the top 10 per cent of rated countries.

When the calculations were run again in 2016, it almost seemed like an error had been made. Estonia had suddenly jumped into a new position as the third-least-risky country in the world, with an overall bribery risk score of 17 out of 100. For comparison, the only countries with better overall scores were Sweden (10) and New Zealand (15) – each of which had already enjoyed a place among the top-five scoring countries in 2014.

The reason for this remarkable shift quickly became clear: beginning in 2014, Estonia had implemented and vigorously enforced a new anti-corruption act, including substantial new asset-disclosure requirements for the 118 Ethical Boardroom | Winter 2017

country’s public officials. These changes were reflected in various Matrix indicators related to government transparency and anti-bribery law, which in turn caused a drop in the associated Matrix domain scores from 39 to five and from 58 to eight. There had been no error – just a focussed and sustained societal effort to cut away at corruption’s roots.

Looking forward

As the Estonia example suggests, the risk model on which the Matrix is based – with its four interlocking domains of interaction, enforcement, transparency and oversight – corresponds to and articulates various positive steps that can be taken within a society to directly confront the causes of public-sector bribery risk. Reducing undue regulatory burden; making anti-bribery BRIBERY COSTS MORE THAN MONEY Corruption can deter private investment

enforcement a political priority; subjecting public servants to appropriate financial scrutiny; supporting media freedom and independence – measures such as these can individually reduce the opportunities for and the temptations of corruption and, taken together, may function in a kind of self-reinforcing ‘virtuous cycle’ of governance.

Of course, this virtuous cycle can just as easily (or more easily) be turned on its head to become vicious. Media can be captured by the state; the interests of a country’s leaders can be obscured; anticorruption can be devalued as an agenda item; hurdles can be erected deliberately to impede access to government information and services. All of this can

happen very quickly, each degradation making the others easier to accomplish.

Corruption works by defying and attacking the elements and ideals of order. Given sufficient latitude, it can display an agility and a ferocity unrestrained by legal, ethical, or institutional norms. Pursued systemically, it can do more than evade those norms; it can act strategically to destabilise the very framework by which the norms are maintained.

The present era of anti-corruption was inaugurated with the passage of the Foreign Corrupt Practices Act by the US Congress in 1977. While that lead has subsequently been followed by several national legislatures and transnational organisations, the threat of prosecution under the FCPA remains one of the clearest and greatest incentives for companies to proactively refrain from engaging in cross-border bribery.

How should such companies respond if a changing world leads to a weakening of prosecutorial resolve against corruption – whether under US law or the law of other states? How to react if political history takes a radical turn away from the ideals that have supported the global economic order over the past century? Would ‘compliance’ still mean anything if the familiar legal proscriptions against bribery were no longer there to be complied with?

Here are some important considerations: the instinct to resist corruption is older than history’s current incarnation of the anticorruption agenda. And the long-term individual and social benefits of free and open exchange are more valuable than complicity’s mess of pottage. These realities are more stable than any given institution – and they will remain realities for your company’s stakeholders long after any change of regime. People like stability and order, and they don’t like corruption: not your customers, not your suppliers, not your trading partners, not your investors – not even your competitors. Even dictators and kleptocrats solidify their power by exploiting people’s anger at perceived crookedness, and by promising to make the trains run on time.

Companies can choose to support the ideals of compliance – not just in the absence of a prosecutorial risk, but precisely because of what such an absence signifies. Robust anti-corruption enforcement goes hand-in-hand with the other elements of a healthy economic order: a government structured to serve rather than strangle; a clarity about its leaders’ financial interests; and a vibrant public engagement in the process of holding those leaders accountable.

As a practical tool, the TRACE Matrix can help you assess this kind of health in particular regions and markets. As a theoretical model, it can help you contemplate the ideals and institutions that permit safe and free engagement with those markets, and to reaffirm your own commitment to support them, come what may. www.ethicalboardroom.com

Steinenring 60, 4051 Basel, Switzerland +41 61 205 55 11

info@baselgovernance.org www.baselgovernance.org

Regulatory & Compliance | Bribery

Sugarcoating extortion Establishing policies to combat bribery and corruption is pointless unless you tackle the problem of corrupt local officials If the rule of law is not adequately enforced, it will be impossible to stanch corruption. In turn, it is not by chance that multinational companies face the most problems with bribery in countries with debased governments.

The most common bribery-related risk facing multinational companies and their third-party vendors is unadulterated extortion by government officials.

Simply put, in high-risk countries, it is either pay bribes or do not plan on doing business in that country. Therefore, the simplistic anti-bribery efforts many companies have implemented over the years are not effective. The reason, all but invariably overlooked, is the fact that in high-risk countries it is corrupt officials who are calling the shots, not a multinational company’s management or its local vendors.

Often, company employees pay off corrupt officials not just to ‘speed up the process’ but also because these same employees often do not feel confident that they can successfully pursue legal courses of action, are afraid that going ‘against the grain’ will jeopardise operations – or both. One example of a problem is when ‘clearance by customs’ is not provided in a timely manner – deadlines are missed or perishable goods may be lost.

Another and often dangerous scenario occurs when bribes are ‘requested’ by members of law enforcement, who are supposed to be protecting people and assets from crime.

Foreign company personnel quickly come to realise that reaching out to local law enforcement for assistance is

Mike Kenealy & Michele La Neve

Mike is the Chief Operations Officer at Insiders Corp. Michele is a Managing Partner at Whitecotton Law International not only all but useless, and doing so only encourages even more ‘requests’ for bribes.

Such practices flourish in countries where the rule of law is not adequately enforced and thus corruption is widespread throughout such a country’s governmental operations – and, typically, up to the highest levels. The collector of an extortion payment usually only keeps a percentage of the money received, with the remainder of the bribe money passed up the food chain for others’ consumption. Further, money extorted by corrupt officials is often used to keep these same corrupt officials in power, fund other nefarious activities – or both.

In fact, the degree of extortion perpetrated by public officials in a high-risk country is symptomatic of how endemic, tolerated and accepted is corruption as a cultural norm. Therefore, in low-integrity countries, it is all but impossible to work around corrupt officials as the flow of extorted money up the food chain invariably short-circuits investigation and prosecution of corrupt officials.

In fact, even worse is common. As problematic as extortion can be for major multinational companies operating in lowintegrity countries, things can be ruinous for smaller companies. For example, in 2008 I was kidnapped while working in a high-risk country because my client refused to pay a provincial police chief’s extortion demand.

The client wanted to bring in trucks to his own local manufacturing facility to reposition some equipment as he was planning to expand operations by turning over some operations to a third party and expand his finished product operations in another facility.

Someone who is still unclear, fuelled a rumour that jobs were leaving the community and the police chief took advantage of the resultant worker unrest to extort money to ‘keep a public road secure’.

The client refused to give into this extortion demand. In turn, the police chief had the foreigners onsite – including me – detained, arrested and then imprisoned. We were held in deplorable and harsh conditions for 31 days. The US Embassy formally called it a kidnapping; even so, the local police chief then demanded more money for our freedom.

CORRUPT OFFICIALS In low-integrity countries, it can be pointless expecting help from local law enforcement

120 Ethical Boardroom | Winter 2017

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Bribery | Regulatory & Compliance

Further, after we were finally released, we were then prevented from leaving the country for another two months via the complicity of other police officials in the country’s capital. Even worse, while we were detained, all my client’s vehicles and contracted trucks were seized, equipment looted and one of his plants was burned to the ground.

Flourishing corruption

I cannot over-stress the fact that officials in low-integrity countries are hungry predators – and once a company gives

in to extortion, it only gets worse. As corrupt officials are typically poorly paid, bribe payments are their main source of personal revenue. As such, corruption flourishes.

Ironically, anti-bribery compliance has turned into a cash cow industry. Companies throw money at everything – except the actual problem. Even worse, many of the service providers in this space do not understand the root problem, nor are they qualified to provide effective guidance.

Compounding the mess, multinationals are increasingly relying on third parties and thus also increasing their risk exposure as they have precious little leverage to implement effective compliance efforts by their vendors.

At best, current practice is to rely on internet-based due diligence with vendors.

Invariable, however, this is not

The most common bribery-related risk facing multinational companies and their third-party vendors is unadulterated extortion by government officials

www.ethicalboardroom.com

an effective way to conduct meaningful third-party due diligence. Reasons include that there is no ‘one size fits all’ when it comes to third party due diligence.

Therefore, specific risks need to be identified on a case by case basis and then the necessary resources applied accordingly.

Not least of the problems to be overcome is that what is needed to obtain legal as well as valid information while conducting third party due diligence invariably differs from country to country and often even within a single country.

Additionally, in many high-risk countries, the internet has yet to reach the government. In fact, a lack of online data both undermines transparency, as well as governmental operations and so facilitates opportunities for even more shakedowns.

As such, local knowledge trumps anything that can be obtained online.

International ‘desktop due diligence’ is thus a myth. Multinational companies therefore need reliable partners with strong local networks to conduct due diligence as records must be manually obtained and direct interviews conducted.

Winter 2017 | Ethical Boardroom 121

Regulatory & Compliance | Bribery Reasons for direct research include home office compliance management is often oblivious to the fact that thriving counterfeit and fraudulent document provider marketplaces exist in many high-risk countries. Whatever bogus material is needed can be readily obtained, even false identification to a notarised document, backdated a decade or more.

At its most basic level, the key concern when conducting due diligence on third-party business partners is: are they conducting business ethically and transparently? The reality is that most multinational companies have nary a clue.

Even more alarming is the fact that third parties are more often further subcontracting out business to other local companies, who are completely unknown to the first party. As such, it is imperative for a multinational to map out its entire supply chain.

Effective training is also essential, especially in high-risk countries. Both employees and third-party vendors must fully understand as well as appreciate what conduct is allowed and what is prohibited. It is imperative that a company clearly spells out that noncompliance will not be tolerated. Action steps include documenting proof of third-party compliance training activities, audit privileges duly understood, as well as walk-away clauses in place.

as well as forestall any undue requests made by local officials. While the settings may be different, mingling is mingling and positive relationships are possible to develop.

Expatriates should also remember that embassies offer a wide range of information and support. Embassy personnel are also local residents and so know the culture and domestic organisations well.

While large multinationals typically have dedicated internal resources to endeavour to develop positive local relationships, it is imperative for smaller and less well-resourced organisations to develop positive in-country

serious impediment to not only his company, but also to his community.

In response, he created a non-profit and assigned a team of his best employees to develop an anti-corruption phone app with an integrated web-based platform that would make it possible for ordinary citizens to report corruption to the proper authorities in real time as well as post their reports on social media for public distribution, exposure and comment.

His team spent over half a year developing the app and website. After beta testing, this first-of-its-kind app was officially launched recently in partnership with his provincial

At its most basic level, the key concern when conducting due diligence on third -party business partners is: are they conducting business ethically and transparently?

Ethics hotlines

Whistleblower lines can be a highly effective compliance tool. Surprisingly, however, many whistleblower lines are both unknown as well as inaccessible to third-party vendors’ employees. An effective whistleblower line must provide both direct and third party employees with a readily accessible and convenient way to report incidents that conflict with home office policies, guidelines and codes of ethics.

Further, an effective whistleblower line can be a multinational’s first line of defence in the field. At the same time, whistleblower hotlines cannot be shunted to rote script responders, routed into Google Translate for translation or – even worse – passed along to a generic, probably not duly vetted and thus potential security risk third party for translation and processing.

Effective whistleblower lines thus must be staffed by trained investigators, who are fluent in the local language(s) and know how best to ask the appropriate questions to obtain as much relevant and detailed information as possible while fielding potentially sensitive reports from a whistleblower. Cultural sensitivity is imperative.

Cultural sensitivity also facilitates other efforts. When operating in high-risk environments, it is advisable to create a strong local network to develop a truly effective understanding of local conditions in general 122 Ethical Boardroom | Winter 2017

SWEETNERS Due diligence can only go so far in combating bribery

relationships as they are far more likely to be targets of extortion.

Even so, despite best efforts, extortion will be experienced. And when it does occur, incidents should be faithfully recorded and duly reported without delay as a defensive measure.

Even if a company effectively undertakes all the above efforts as well as strives internally to be as ethical an organisation as possible, if that company conducts business with unethical parties and/or other businesses operating in the same setting are giving into extortion demands, it all but impossible to operate both ethically and profitably.

Action against corruption

Companies thus need to seek out, vet, and support local efforts that expose corruption to public scrutiny. In this regard, I have seen a recent explosion of inspired homegrown approaches to combating corruption.

For example, I recently spoke with the CEO of an India-based software company about his efforts to counter corruption. Corruption is a

government. Even better, this app can be readily migrated to anywhere where smartphones are commonly used and will operate all but autonomously at minimal cost.

Multinationals have the ability through their local agents to seek out and then support the implementation of similar proactive initiatives in other low-integrity settings, including those where a multinational may not have a direct physical presence.

It is crucial to appreciate that when corruption is tolerated, it affects the entire food chain. Both residents and multinationals alike suffer all manner of adverse consequences from the cancer that is corruption. Distant corporate headquarters cannot simply promulgate policies and practices; rather, they must support the efforts of those on the front lines.

To successfully combat corruption, it is thus imperative that multinationals work in concert with locals, other companies, anti-corruption NGOs and ethical anti-corruption enforcement officials to confront the underlying root problem: corrupt local officials. www.ethicalboardroom.com

Regulatory & Compliance | Yates Memo

FCPA enforcement: The individual criminal prosecution gap The Yates Memo has shifted the focus of criminal investigations from corporations to individual wrongdoers. Only time will tell if it succeeds in holding more of them to account

Just over one year ago, US Deputy Attorney General Sally Yates issued new guidance to Department of Justice (DOJ) attorneys, emphasising individual accountability in all investigations of corporate misconduct.

Although the Yates Memo has not yet led to a meaningful uptick in individual criminal prosecutions under the Foreign Corrupt Practices Act (FCPA), it lays the 124 Ethical Boardroom | Winter 2017

Kristen Savelle

groundwork for more even-handed enforcement of the statute and proposes a system of justice that treats corporate executives the same as other criminal wrongdoers. Whether the DOJ can turn that rhetoric into reality remains to be seen.

The Yates Memo

Released on 9 September 2015, the Yates Memo outlined six key steps that prosecutors are expected to take in any

Associate Director of Empirical Research for the Rock Center for Corporate Governance at Stanford Law School investigation of corporate misconduct to most effectively â&#x20AC;&#x153;pursue the individuals responsible for corporate wrongsâ&#x20AC;?.1 The most significant step requires companies to provide the DOJ with all relevant facts relating to the individuals responsible for corporate misconduct to qualify for any cooperation credit. www.ethicalboardroom.com

Yates Memo | Regulatory & Compliance The concept that corporate cooperation includes providing the government with all relevant facts about individual wrongdoers is nothing new; individual accountability has long been a stated priority at the Department of Justice.2 What is new is the consequence of not providing this information. In the wake of the Yates Memo, divulging all information about the individuals responsible for corporate misdeeds is a threshold requirement for receiving any cooperation credit at all.3 The DOJ has since clarified that a company can be eligible for cooperation credit even if it is “unable to identify the culpable individuals following an appropriately tailored and thorough investigation”, so long as it “provides the government with the facts and otherwise assists [the government] in obtaining evidence.”4 The DOJ has also indicated that, going forward, all corporate plea and settlement agreements will include a provision that requires the companies to continue to provide relevant information to the government about any individuals implicated in the wrongdoing and that a company’s failure to continue cooperating against individuals will be considered a material breach of the agreement and grounds for revocation or stipulated penalties.5 Following the release of the Yates Memo, the DOJ implemented a pilot programme designed “to promote greater accountability for individuals and companies that engage in corporate crime by motivating companies to voluntarily self-disclose FCPA-related misconduct, fully cooperate with the Fraud Section [of the Department of Justice] and, where appropriate, remediate flaws in their controls and compliance programs”.6 Companies that self-disclose, fully cooperate, including by providing information about individual wrongdoers, remediate and disgorge all profits resulting from the FCPA violations will qualify for mitigation credit that can affect the type of disposition, the amount of fine imposed, or the determination of the need for a monitor.7

A historical review of individual criminal prosecutions under the FCPA

In order to put the Yates Memo in context and to understand both its significance and potential impact, it is important to take a closer look at the DOJ’s historical record of prosecuting individuals for FCPA offences.

In the last five years,8 the DOJ has criminally prosecuted 60 individuals for FCPA-related offences and 40 individuals for violating the anti-bribery, books and records and/or internal controls provisions of the FCPA.9 During this same time period, the DOJ prosecuted 39 corporate groups for FCPA violations.10 Table One (above right) details the number of criminal FCPA prosecutions per year between 2012 and 2016. www.ethicalboardroom.com

TABLE ONE: FCPA PROSECUTIONS BETWEEN 2012-2016 25 14 20 15

7 9 13

10 5 0

7

2 8

10

6 3 2012 2013 2014 2015 2016 ■ Individuals ■ Corporate groups

According to publicly available documents, the DOJ criminally charged ten individuals with FCPA offenses in 2016. While the absolute number of individual defendants increased last year, the ratio of individual to total defendants actually declined. In 2016, individuals represented 42 per cent of all FCPA defendants, which is far below the 2015 ratio (80 per cent) and slightly below the five-year average of 51 per cent.11 Most of the individuals criminally prosecuted under the FCPA in the last five years were employed by or directly affiliated with a private company. Of the 40 individuals prosecuted for FCPA offences between 2012 and 2016, three (or less than eight per cent) were employed by public companies and 37 (or 92 per cent) were employed by or affiliated with private companies, including private companies that operate as subsidiaries and joint ventures of large, public companies.12

Most of the individuals criminally prosecuted under the FCPA in the last five years were employed by or directly affiliated with a private company Consider that during the same period, 23 public companies and 31 private companies were criminally charged under the FCPA and that no person employed by any of the 23 public companies has been criminally prosecuted to date.13 In the early years of FCPA enforcement, simultaneous prosecution of companies and company agents was the norm rather than the exception. Between the FCPA’s enactment in 1977 and the end of 2004, 83 per cent of criminal enforcement actions against companies involved a related criminal prosecution of individuals.14 Those numbers have flipped in recent years.

Between 2012 and 2016 inclusive, the DOJ criminally charged 39 corporate groups15 with FCPA violations.16 Only six of those

prosecutions (or 15 per cent) have involved related criminal enforcement actions against company employees or agents.17 That means that 85 per cent of corporate prosecutions initiated in the past five years have involved no related criminal action against the employees or agents who caused or facilitated the FCPA violations. If you add to the mix three recent pilot programme declinations that terminated investigations against corporate groups despite alleged anti-bribery violations, then the percentage of corporate actions involving a related individual prosecution goes down even further, to 14 per cent.18

Understanding the individual criminal prosecution gap

Given the universally recognised truism that “corporations do not act criminally, but for the actions of individuals”, why aren’t more individuals being criminally prosecuted for corporate FCPA offences?19 There are several possible explanations.

To begin with, holding company employees criminally liable for FCPA offences can prove tricky. Prosecutors must establish the requisite knowledge and intent20 “beyond a reasonable doubt” and not by the “preponderance of the evidence” standard that governs civil cases in the United States.21 When the misconduct occurs at a large corporate enterprise, it can be difficult to determine who carried out the criminal acts and who was ultimately responsible for the business decisions at issue.

High-ranking executives can be particularly difficult to prosecute if they are removed by several layers from the day-to-day operations of the enterprise.22 Even if an individual is identified, he or she may be responsible for only a small portion of a large, complex bribery scheme that could span several continents and multiple affiliated entities.

Prosecutors may be further constrained by legal restrictions on the production of documents from companies that operate globally, including restrictive foreign data privacy laws and a limited ability to compel the testimony of witnesses abroad.23 In addition, the very length of investigations – which often drag out for several years – can make it difficult for prosecutors to bring criminal charges against individual defendants before the statute of limitations expires.24 The DOJ may also decline to criminally prosecute individuals who are subject to ongoing or imminent litigation initiated by another US or foreign agency. In fact, the clear majority of individuals charged with FCPA-related misconduct have been sued by only one US agency or the other, whether due to agency deference, lack of jurisdiction, or inability to establish criminal intent.

However, the prospect of parallel enforcement has not stayed all criminal prosecutions.

Since the FCPA’s enactment, 28 individuals have been charged by both the SEC and the DOJ for FCPA-related offences.

Winter 2017 | Ethical Boardroom 125

Regulatory & Compliance | Yates Memo More fundamentally, enforcement actions against companies may not lead to criminal prosecution of company employees if there is insufficient evidence that an FCPA violation occurred, notwithstanding the company’s admission of wrongdoing. Companies almost universally25 settle FCPA claims to avoid the severe consequences that may result from criminal conviction, including reputational harm,26 delicensing,27 debarment from government contracts,28 or exclusion from federal programmes,29 and to access the reduced fine and other ‘carrots’ offered by the government to cooperating companies.30 In recent years, these settlements overwhelmingly have taken the form of deferred prosecution agreements (DPAs) and non-prosecution agreements (NPAs).31 DPAs and NPAs are privately negotiated agreements between the government and the defendant in which the government agrees to delay (in the case of a DPA) or forgo (in the case of an NPA) prosecution in exchange for the defendant agreeing to comply with certain terms and conditions, such as payment of a fine, admission of wrongdoing and a prohibition on public statements contradicting those admissions.32 An NPA is never filed in court.

A DPA is filed in court, but “judges routinely ‘rubber-stamp’ DPAs without inquiring into whether factual evidence exists to support the essential elements of the crime alleged or to determine whether valid and legitimate defences are relevant to the alleged conduct.”33 Critics contend that DPAs and NPAs may be predicated on scanty facts and legal conclusions that are never challenged in a court of law or subject to exacting judicial scrutiny.34 They argue that these alternative forms of resolution allow the government to exact disproportionate remedies from corporate offenders for conduct that may not amount to a provable FCPA violation.35 Prosecutors have significantly less leverage over individuals. Faced with the prospect of heavy fines, incarceration, or both, individuals are much more likely to challenge FCPA claims, especially those based on thin facts or questionable jurisdictional grounds.36 Prosecutors may be reluctant to pursue individual wrongdoers based on the same facts and legal theories that support a

corporate resolution because they know there is a higher likelihood that the theories will be examined, and possibly rejected, in a court of law.37 In fact, empirical evidence suggests that as corporate DPAs and NPAs have increased in popularity, the number of corporate enforcement actions involving a related individual prosecution has declined precipitously.38

Impact of the Yates Memo

As Table One reveals, the Yates Memo has not yet led to a meaningful uptick in individual prosecutions for FCPA offences.39 Does this mean the Yates Memo has failed? Not at all.

Prosecutors require time to incorporate the memo’s directives into their policies and procedures and to translate those directives

jurisdictional bounds of the FCPA through corporate DPAs and NPAs, the DOJ may be disinclined to risk judicial scrutiny of expansive legal theories or flimsy evidence in a prosecution of company employees, even if the company admits to wrongdoing and hands over all relevant information about culpable individuals.42 On the other hand, the Yates Memo could curb some of the perceived excesses of FCPA enforcement. By focussing on individuals from the outset of an investigation, including the factual and legal grounds necessary to support an individual indictment, the memo could encourage prosecutors to spend more of their energy on cases with provable FCPA violations and less time on cases of questionable merit. The memo could also

The number of corporate prosecutions with a simultaneous prosecution of managerial agents has dwindled in recent years. This is despite public outcry over the dearth of individual prosecutions in the wake of the financial crisis into new enforcement actions. Investigations commenced around the time of the memo’s release are thus likely to be more substantially impacted by the memo than are investigations that were already well-established when the policy shift was announced.40 Whether the Yates Memo will ultimately lead to more individual prosecutions remains an open question. Individual accountability has long been a touchstone of criminal enforcement, yet the number of corporate prosecutions with a simultaneous prosecution of managerial agents has dwindled in recent years. This is despite public outcry over the dearth of individual prosecutions in the wake of the financial crisis and increased public pressure to criminally charge individual wrongdoers.41 Even if the Yates Memo does reflect a significant policy change, there is no guarantee that company employees will be prosecuted. So long as the DOJ continues to push the scope and

yield tangible benefits in the form of additional deterrence. Individuals faced with a higher prospect of criminal prosecution – including significant fines and jail time – may be less inclined to sanction bribery payments, or to hide those payments in the company’s books and records. And those individuals could, in turn, effect positive change within the corporate culture.43 At the very least, the DOJ’s stated intent to focus on individuals from the outset of an investigation and the demonstrated willingness of companies investigated for FCPA-related misconduct to share information about culpable individuals with the government, suggests that white-collar criminal investigations may be moving in the right direction.44 Whether the new policies will correct the imbalance in criminal enforcement of the FCPA remains to be seen.

Footnotes will be published in full online

FORCE OF LAW The Yates Memo may deter wrongdoing more than it increases convictions

126 Ethical Boardroom | Winter 2017

www.ethicalboardroom.com

Make anti-bribery and corruption your priority Hogan Lovells recently launched its Global Bribery and corruption review 2016 â&#x20AC;&#x201C; a guide to developments in anti-bribery and corruption regulation and enforcement. In it we review events, examine trends, and project what might happen in 2017. For a copy and additional information go to www.hoganlovellsabc.com

Hogan Lovells is an international legal practice that includes Hogan Lovells US LLP and Hogan Lovells International LLP. Š Hogan Lovells 2017. All rights reserved.

Regulatory & Compliance | Corruption

Delivering an anti-corruption framework that works In today’s increasingly complex global environment, it is no longer a matter of whether an organisation has an anti-corruption framework in place, but how effective its framework is. Failure to implement an anti-corruption programme that works, can have far-reaching consequences.

The first – and most obvious – is exposure to losses from fraud and corruption itself.

This is not the only risk however, as there is a growing number of jurisdictions around the world, where a failure to apply effective processes and procedures that prevent employees (or agents) from offering bribes, will result in severe financial penalties.1 Although there is no silver bullet or ‘one-size-fits-all’ approach to designing and implementing an effective anti-corruption framework, there are a number of critical elements that should be included. I will outline several of them in this article, including how they can be implemented.

Key elements of an anti-corruption framework

For an anti-corruption effort to be successful, it needs to be part of an integrated holistic approach. The structure, or framework, needed for this is made up of a number of inter-related components, which when combined, form the foundation on which to anchor the individual initiatives. Each element plays a critical role in countering corrupt behaviour, while at the same time helping develop a strong ethical culture.

Nailing the right strategy will not only help prevent and identify cases of fraud but will help protect your reputation, too Jeremy Sandbrook

Chief Executive, Integritas360 Although anti-corruption programmes should be founded on a risk-based management approach, this is only one component needed to develop an effective anti-corruption framework. So what does such a framework look like?

Tailored to meet an organisation’s unique corruption-risk profile, an example of a generic anti-corruption framework is outlined in Figure A (below). Made up of a series of interlocking components – or building blocks – it is broken down into three main parts: the pillars that hold the framework up; the foundation on which they are built; and the overarching structure that binds it together.

Each of these is outlined in more detail below.

The building blocks

Strong, well-designed pillars are a critical element, which, when taken together form the framework’s main building blocks. While the number used will vary depending on the organisation’s specific context, the framework outlined in Figure A contains six. As a general rule, they should be based on the three elements (or themes) of corruption prevention, detection and response (see Figure B).

Just as importantly, their focus should not be limited to implementation aspects only, but

FIGURE A: ANTI-CORRUPTION FRAMEWORK

include continuous monitoring and improvement as well. A brief description of each of the framework’s pillars is outlined below: Pillar 1 – Corruption prevention policy An integrated corruption prevention and control strategy is an essential component of any anti-corruption framework.

Made up of both a corruption control strategy and a plan on how it is to be implemented, the strategy should include a clear definition of corruption and the approach used to control it (at strategic, tactical and operational level).

Supporting the strategy, the corruption control plan outlines the intended actions needed to implement and monitor the various corruption prevention, detection and response initiatives required. Both the corruption control strategy and the corruption control plan should be reviewed on a regular basis.

Pillar 2 – Code of ethics/code of conduct A key strategy in managing corruption is the implementation and maintenance of an ethical organisational culture. Central to this is a comprehensive code of ethics. Containing a high-level aspirational statement of values, it should also include specific details of the types of behaviour the organisation deems as unacceptable. To be as effective as possible, it should be aligned and integrated with the organisation’s corruption prevention policy.

Pillar 3 – Corruption risk management At the heart of anti-corruption efforts is a proactive risk-based management approach.

Identifying corruption risks will enable the organisation to develop the appropriate risk-mitigation strategies, and assign corruption prevention resources to where they are needed most.

FIGURE B: ANTI-CORRUPTION PILLARS BY THEME

Preventing corruption and developing an ethical culture

Prevention

Consistent Enforcement & Deterrence, Transparency 1 Corruption prevention policy

2 Code of ethics/code of conduct

3 Corruption risk management

4 Detecting corrupt practices & compliance breaches

5 Responding to corrupt conduct & compliance breaches

6 Education and awareness

Strong leadership, adequate allocation of resources and sufficient political will 128 Ethical Boardroom | Winter 2017

Detection

Pillar 3 Pillar 1 Corruption Corruption-risk management prevention policy Pillar 4 Detecting Pillar 2 corrupt Code of ethics/ practices code of conduct Pillar 6 Pillar 3 Corruption-risk Education management and awareness Pillar 6 Education and awareness

Response Pillar 5 Responding to corrupt conduct

www.ethicalboardroom.com

As part of this, a comprehensive risk assessment should be carried out (at least annually) in which all potential fraud and corruption risks are identified, analysed and evaluated.

Pillar 4 – Detecting corrupt practices Early detection is vital in order to limit the spread of corrupt conduct and minimise damages from it. While the majority of cases are reported by tip-offs, managers play a key role by ensuring they provide the appropriate level of supervision and checking.

An effective organisational internal reporting system, sound complaint and grievance processes and a comprehensive internal audit and work review programme, also facilitates detection. The implementation of a whistleblower system is also essential.

Pillar 5 – Responding to corrupt conduct Responding effectively to suspected cases of corruption is critical. This involves a well-conducted internal – and if necessary external – investigation to ascertain the facts.

If proven, prompt reporting to the police (and/or other bodies where necessary) and appropriate disciplinary action is essential.

The information gained and lessons learned from each case, should form part of an on-going review of corruption prevention controls to ensure they are as comprehensive and effective as possible.

Pillar 6 – Education and awareness The most important anti-corruption resource at an organisation’s disposal is its own staff.

In the majority of cases, employees will come forward if they know what to look for and how to report it.

Formal and informal education and corruption awareness raising is essential.

Encouragement and space should be given to allow staff to openly talk about the topic, making them more comfortable about coming forward if an issue subsequently arises.

Many fraud and corruption cases continue for years before they become known to the organisation, as managers and/or staff are not aware of the warning signs, or the atmosphere is not conducive to reporting them.

A solid foundation

For the pillars outlined above to be effective, they need to be based on a strong, stable foundation. This involves a number of components. The first is a combination of political will and the tone set at the top.

As reported in the Global Ethicist: “When leadership experts, organisational behaviourists, ethicists and risk managers look at what creates (or destroys) a culture of integrity and accountability, a major focus, rightly, is on the tone from the top.

What leaders say and especially what they do has broad and pervasive effects on the organisation and its people.”2 www.ethicalboardroom.com

Put more succinctly, if an organisation’s leaders do not demonstrate they are genuine about anti-corruption, why should their staff? The issue is even more important if the existing organisational culture has indirectly tolerated or ‘ignored’ corruption.3 At the heart of setting the ‘right’ tone is a proactive approach to the topic. This includes an organisation’s leaders: n Being at the forefront and publicly promoting corruption prevention efforts.

Strong on-going statements need to be made (both internally and externally) around the organisation’s anti-corruption position.

The messages should be clear and consistent n Making it a priority by elevating the topic to being a key strategic issue and embedding it into the relevant parts of the organisation’s planning processes n Modelling the type of ethical behaviour required (and expected) from staff.

Managers and, in particular, senior managers, need to show that they are committed to it and live the organisation’s anti-corruption values

To be effective, anti-corruption programmes must be backed up by an effective enforcement mechanism.

Without this it runs the risk of becoming a ‘toothless tiger’ The second is sufficient and appropriate resourcing. While this should be an automatic ‘given’, surprisingly, a lack of resources continues to be a key reason why so many anti-corruption programmes fail to produce the promised results.4 While not the only components required to lay a strong anti-corruption foundation, the right tone at the top, backed up by sufficient political will and the appropriate level of resources to make it a reality, more than anything else, will dictate the organisational values that are rolled-out.5

The cement binding it together

The third element of a successful anti-corruption framework is its overarching structure. The key here is strong and consistent enforcement and deterrence, backed up by a high level of transparency.

To be effective, anti-corruption programmes must be backed up by an effective enforcement mechanism. Without this it runs the risk of becoming a ‘toothless tiger’. Strong and consistent enforcement demonstrates an organisation’s genuine commitment to fighting corruption. It is also a reflection of the effectiveness of its anti-corruption framework, as successful enforcement actions serve as a strong deterrent to those acting (or thinking of acting) corruptly.

If there are no sanctions in place – or worse – sanctions aren’t actively enforced, those acting corruptly will continue to do so, while those who would normally report wrongdoing would be reluctant to come forward (drastically reducing the deterrence factor).

In support of this is the need for a high level of transparency. Based on the premise that “sunlight is … the best of disinfectants [and] electric light the most efficient policeman”, transparency is viewed by some as the first line of defence against corruption.6 As stated by the UN Global Compact: “Transparency sets a tone of openness, accessibility and accountability, building confidence among [staff members] ….

Transparency of commitment to values and openness about policies and processes will not only enhance [an organisation’s] reputation, but act as a substantial deterrent to those wishing to act corruptly.”7 In other words, a combination of secrecy and the failure to strongly enforce sanctions, is the antithesis of corruption prevention.

Making it happen

The final aspect of an effective anti-corruption framework is its implementation. While there is no ‘right-way’ of doing this, the process should be iterative in nature, with the structures needed to achieve it being well embedded into the broader organisation.

While a phased approach is the most common method, it is important to ensure that the various building blocks outlined above, are implemented at the right time and in the right sequence.

Final thought

The argument that designing and implementing an anti-corruption framework is complex and resource heavy is a fallacy.

While it is best to involve an experienced anti-corruption specialist in the process, the overall level of resources required to achieve a good return on investment does not have to be excessive. Of greater importance is the level of commitment, along with a genuine desire and belief that corruption can be prevented.

Footnotes will be published in full online

Winter 2017 | Ethical Boardroom 129

Regulatory & Compliance | Compliance Training

What makes a first-class training programme?

Following the right compliance training programme will arm you with the knowledge for becoming the best compliance professional Firstly, an admission: I love training. Not being trained, you understand, but rather training others. (I actually don’t like being trained at all; when attending training, I spend more time assessing the quality of the training than I do paying attention to what I’m supposed to be learning. Most trainers do not make good training session attendees).

I did not realise I loved training until an almost accidental change in career direction meant I moved from being a practising compliance officer into training others to be compliance officers. It was the 130 Ethical Boardroom | Winter 2017

Jonathan Bowdler

Head of Regulatory Compliance, International Compliance Training best almost-but-not-quite accidental career change I ever had.

It is not possible to put all my thoughts as to what makes a really first-class training programme into 1800 words, but what writing this article has done is made me think very carefully about what the critical success factors are in achieving this. So, I am going to focus on three key areas; the quality of the trainer in face-to-face delivery; the quality of the training materials; and understanding the objectives of the training - and making sure that the training meets these objectives.

1

The quality of the trainer Not all training requires a trainer to be

present. However, it has long been acknowledged that face-to-face training, if done well, is the best type of delivery for imparting knowledge and understanding.

Knowledge can be learned from written materials or computer-based training platforms, but understanding requires challenge, it requires real-world application and it requires clear explanations.

The most powerful word in the English language is ‘why’ and only discussion, debate, challenge and rationale can lead to true understanding. And understanding should be an objective for almost all training programmes. Without understanding you may well be able to train someone to do a job or carry out a task, but what happens the first time they are challenged? What happens when something goes wrong or something unexpected occurs? www.ethicalboardroom.com

Compliance Training | Regulatory & Compliance So, if face-to-face training is the gold standard for imparting knowledge and understanding, then the critical success factor for the impact of that training is the quality of the trainer. Subject matter experts can be found for any topic. But finding a subject matter expert who can encourage challenges and debate, listen to counter arguments and objections and who can also influence and persuade others is very, very difficult.

By their very nature, someone who is prepared to stand in front of a room and present themselves as the subject matter expert is not going to be shy, but are they also going to be able to respond to new questions and challenges never asked before? Are they confident enough to welcome these questions and challenges and respond to them positively and without prior warning?

This means that as well as a subject matter expert, a quality trainer plays other key roles:

outside of the training room is essential so that the actual training material content can be placed in perspective.

The format of the training materials should be as engaging as possible. Some variety is desirable to prevent boredom setting in and to appeal to each individual’s different learning preferences. In addition to any written materials, this type of integrated approach could include:

success factor in any project, or indeed wider undertaking. Over-complexity, trying to meet multiple demands or simply trying to keep too many people happy, often results in the fundamental objectives of the training programme being unclear or diluted. If you want your attendees to consider the training worthwhile then they must see a benefit in it for them once completed. Otherwise why did they have to take the training? Training has a cost, not least the attendee’s time in n Virtual classrooms where face-to-face attendance, so the potential benefits must be training is not possible identified and clearly communicated. Indeed, n Live or pre-recorded webinars/ the attendees should be able to see the videos/interviews benefits themselves (with a little guidance if n Self-assessment questions (SAQs) for required) if the training has been successful. checking progress along the way One of the most critical stages of training is n Practical tasks to enable the application the review at the end, summarising what has of the learning been learned and why what has been learned n Discussion forums where attendees is of importance. It may take three hours of can ask questions and share knowledge training to understand a topic, but the key and experience learning points that come out of this – and n Psychologist – Identifying and n Real world case studies to demonstrate how that key learning can be utilised – can understanding the needs and practical application of the learning and be summarised in a 15-minute review at behaviour of their audience and the the consequences of failing to do so the end of the session. These 15 minutes can individuals within that audience be the most important of the three hours.

And the written materials themselves n Performer – Being able to keep their When asking immediately after a training need to be engaging. What do I mean audience engaged and entertained so that session whether it was worthwhile or not you by engaging? Well, not just lines their concentration levels are kept high. could get a full range of responses. But even of text. The text must be broken I have always enjoyed using humour in if 95 per cent of attendees say “I keep six honest that they found it interesting and up by relevant pictures, diagrams, training sessions and have no doubt that serving men case-study boxes, SAQs as you this also enhances the learning environment useful, unless something changes go, etc. Consideration also needs n Motivator – Demonstrating the benefits in the way that they do things They taught to be given to the delivery of of what the attendees are learning so when they return to their ‘normal’ me all I knew. the materials. Online learning that they can clearly see the practical role, it will have been a complete Their names platforms have been with us for output of the training session waste of time and money. are What and many years now, but they need to be At least one of the overriding And all of this must be done in direct easy and intuitive to use if a student Why and When objectives of training will have And How and response to the needs of the attendees. is to get the most from them. been to bring about change in Where and Who.” some way, shape or form. Even if The exact same training session might well Frustration with IT platforms or need to be run with a significantly different administration can severely detract Rudyard Kipling that objective was just to change approach, depending upon the psychological from the learning experience. the way an individual thinks, makeup of the attendees, both individually this is a practical change. But for attendees Meeting the objectives of the training and as a group. So, you can immediately to derive real benefits, objectives for change (and bringing about change) add the attributes of adaptability and should be set within the training and a system As with any project, a training programme flexibility to the above. should be in place to be able to monitor and should start by clearly identifying and follow up that change.

The quality of the training materials articulating its objectives. While this will Summary The accuracy of training materials must include the individual objectives of the trainees, So, to follow my own advice (this article be a given and so I do not intend to dwell at the planning and implementation stages could be considered a short written training on that here. However, when training in a it should focus upon the overall strategic programme) here are some simple and dynamic area, such as my area of expertise objective(s) of the training. The overall clear key learning points to take way. (regulatory compliance in financial services), objectives of a training programme should keeping up to date with current events is be SMART (specific, measurable, assignable, The quality of the trainer essential in maintaining credibility in the realistic and time-related). The what, when, A subject matter expert with the eyes of the training attendees. It is a perfectly why, how, where and who (or Kipling) questions ability to listen and adapt, and lead the fair challenge for a practitioner to say to the must also be a focus at the planning stage to learning process trainer ‘What do you know about it? You don’t ensure all possible considerations are discussed The quality of the training materials have to actually do the job’. Understanding and all risks and potential issues are addressed.

Must be accurate, presented in an engaging the current environment and, therefore, the Clarity in the objectives of the training will and pragmatic way with variety where possible pressures and risks, faced by your attendees assist in simplicity. Simplicity is a critical Meeting the objectives Define from the outset. Simplicity For attendees to derive real benefits, objectives for change and clarity.

Clear benefits to all

3

2

1

2 3

should be set within the training and a system should be in place to be able to monitor and follow up that change

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So, what are you going to do with these points? And why?

Winter 2017 | Ethical Boardroom 131

Regulatory & Compliance | Corruption

Whistleblower: A hero, a villain or simply a fool?

A code of ethics means nothing if employees who have the courage to expose corruption are not protected Fifteen years ago, I lived through a professional experience that I imagined was something rare in the business world.

To fulfil the words and spirit of the code of ethics of one of the largest oil companies on the planet, I had to report to management a multi-million fraud and corruption scheme in the regional sales department, for which I had temporarily assumed responsibility.

The illegal activities and illegalities I had discovered also involved various types of conflicts of interests and even the issuing of ‘cold invoices’. According to my surveys, the looting of the company’s coffers was more than $20million a year.

Despite the seriousness of the facts, the commercial director and the general manager of internal audit, didn’t give me any guidance on how I should proceed from that moment.

Nor was I praised for my attitude in guarding the name, the reputation and the equity of the company. I imagined that situations of this magnitude should be conducted in this way to ‘protect’ the whistleblower.

A few weeks later, during my vacation, the company conducted an ‘internal audit’. No breach of the code of ethics had been verified and no misappropriation of money had been proven. When I returned to my functions, I was fired. When I appealed to the ethics committee of the company’s Brazilian subsidiary, the CEO sent me an answer. By the content of the letter, it was evident that the scheme of fraud and corruption that I had reported had metastasised throughout the company.

So, I asked the board to help me because it is the ‘highest authority’ in and out of the corporate walls. The board is composed of the shareholders’ representatives as well as the chairman and the global CEO. It is the members of the board who determine the guidelines 132 Ethical Boardroom | Winter 2017

Douglas Linares Flinto Chairman & CEO at Brazilian Business Ethics Institute

for the executives to conduct the business.

The board is also the personification of the ‘corporate governance’. And the board is much more than all of this. The board is the guardian of ethics and must ensure compliance with the company’s code of ethics.

Investigations and lawsuits

As a reply to my request, the board authorised the chief legal officer to enter a (frivolous) lawsuit against me and the Brazilian Business Ethics Institute, demanding an indemnity of $30 million for hypothetical slander and defamation. And to disqualify me and mislead an Italian magistrate, the company used a ‘deceitful version’ supported by the senior vice president of internal audit that accused me of lying and having a ‘non-collaborative and reticent’ attitude to the company’s undercover investigation, which breached the relationship of trust and resulted in my dismissal. That is, the company ‘killed’ the whistleblower in Brazil and tried to do the same in Italy, turning the whistleblower from a hero into the villain.

After losing in the first instance and not fulfilling a pre-established deal, the company appealed the sentence and the next hearing will take place in 2018.

The honest and Sometimes, incredible as it may seem, the whistleblower is labelled, pejoratively, incorruptible as the snitch of the story for handing in employee is not their partners or superiors and has their respected, is not loyalty questioned by everyone.

But, most of the time, people don’t use promoted and is the most effective corporate tool to detect always criticised. ethical problems: the channel of complaint.

Many of them don’t feel comfortable But the dishonest denouncing for fearing that the matter and sly employee won’t be handled with the necessary confidentiality. Many imagine that nothing can always climb will be done and no one will be punished. the rungs of Others keep quiet because they know the corporative that the biggest corporate law is the one that says: “They give the orders. You obey hierarchy them.” Some others act wanting to take www.ethicalboardroom.com

Corruption | Regulatory & Compliance

VILLAIN OR VICTIM Whistleblowers can be seen as protectors of reputation or disloyal employees

advantage, even if someone or the company itself is harmed. Whoever does not do it is called a ‘fool’ and the one who gets the admiration is the smart one that defrauds what the company can’t protect. The honest and incorruptible employee is not respected, is not promoted and is always criticised. But the dishonest and sly employee can always climb the rungs of the corporate hierarchy.

Because of this type of culture, it is evident to everyone within the company that the ethical employees are fools and the rogues are admired. But, most of the people are still intimidated and keep quiet about stories like mine that had harmful consequences for those who decided to blow the whistle, for those who sounded the alarm: retaliation, loss of job and being vetoed in the labour market.

Silencing whistleblowers

Compliance programmes weren’t capable of changing this sad reality and the inconsistent situation with acceptable standards of ethical conduct. The employees will receive the code of ethics, attend the ethics and integrity training, they will say ‘yes’ to everything and nothing will change. Not even in countries where there are effective whistleblower protection laws, such as the US and the UK, have they been able to end once and for all with the silencing of the whistleblowers.

I am pretty sure that if stories such as mine begin to emerge from the underworld of business and the whistleblowers are encouraged to denounce and confront unethical companies, that transparency, honesty, integrity, character and ethics will become the true corporate values. It would have the power to engage employees around the world with a noble and commendable purpose, capable of achieving the corporate mission that will add value to the investors and shareholders, customers and consumers, partners and suppliers, and reflect on productivity and profit, on risk mitigation and improvement of reputation, ensuring business continuity.

I did what was right and I was the victim of my own complaint. I had my corporate career destroyed by an unethical company that should protect me as it is imperative in its own code of ethics. Do I regret anything? Quite the contrary. I would do it again. Because doing the right thing, because acting ethically and with integrity, makes our life worth living!

I also make the words of Malala Yousafzai – the young advocate for women’s education, who was shot on her way home from school – my own: “I tell my story not because it is unique but because it is not” and I hope my story can be served as an example, motivation and inspiration to other whistleblowers who are being silenced and their careers and reputations buried around the world by companies that don’t respect their codes of ethics, by employees and executives who steal corporate coffers and the board that pretends nothing happens. www.ethicalboardroom.com

Winter 2017 | Ethical Boardroom 133

Global News Middle East

Boursa Kuwait reveals its new chairman

MENA family businesses ‘need to become institutions’ Family businesses in the Middle East and North Africa (MENA) region need to embark on an institutionalisation journey that “seeks a definitive separation between business and family”.

According to management consultancy Strategy&, without strong governance, institutionalisation and strategic focus, family businesses are not attractive to lenders.

Strategy& says: “Ultimately, family businesses should recognise that beyond any required governance and ownership initiatives,

their only sustainable source of value creation comes from ensuring they have a solid growth strategy for the business and the ability to execute their defined initiatives, irrespective of ownership type and control.”

In a study, Strategy& said it had witnessed some regional family businesses increasingly professionalising their boards by hiring independent directors who are non-family members, non-shareholders and non-executives who help to maintain a “business-first” perspective at the board level.

Thomson Reuters to host Dubai regulatory summit Global news agency Thomson Reuters and the Dubai Financial Services Authority (DFSA) will co-host the 11th MENA Regulatory Summit in Dubai this February.

The MENA Regulatory Summit, the region’s forum for the financial compliance community, will cover themes, such as corruption and anti-money laundering, information security and future risk scenario planning.

According to the findings of the Thomson Reuters MENA Financial Report 2016, half of compliance professionals in the region have significantly increased their compliance spending over the last two years and 52 per cent expect a significant increase in compliance spending in the next two years.

Governance code for public firms in Oman

Oman Centre for Governance and Stability (OCGS) has agreed to prepare a code of governance for government companies.

The agreement with the Ministry of Finance is “in response to the Ministry’s wish to set up clear standards to enhance the practices of wise management on best standards of performance leading to growth and expansion of

134 Ethical Boardroom | Winter 2017

The Kuwait Stock Exchange has selected Mohammed Ahmed Alsaqqaf as the new chairman of its board of directors.

Alsaqqaf, chairman of the board’s executive committee and nomination and remuneration committee, has pledged to continue developing a competitive leading regional stock exchange that “incorporates international level processes and standards”.

In December, Kuwait’s emir selected previous chairman Essam Abdul Mohsen Al-Marzouq to head the country’s oil ministry.

business and investments”.

Sayyid Hamid Sultan al Busaidy, executive director of OCGS, commented that upgrading efficiency, surveillance and transparency would lead to “increased confidence in the national economy which would increase the rates of economic growth and deepens their role in the growth of savings and increase the return on investment”.

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Best in class boardrooms require a pipeline of the best, most diverse talent, which has to deliver in the most challenging of environments. This platform aims to empower the next generation of board talent and builds Get involved in this groundbreaking initiative.

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Risk Management | Reputation

Deploying reputational risk 2.0 The new strategic governance and value creation imperative: setting up a framework for turning risk into an opportunity for good, sustainable business

1

An inflection point

Because of the unrelenting pace of change in this age of digital transformation, explosive social media and rising stakeholder expectations, we are at an important inflection point in organisational reputation risk management.

While companies and other entities (NGOs, government agencies, universities and others) have been managing their brand and reputation for decades (even centuries), most still don’t understand the keen difference between brand and reputation management, on the one hand and reputation risk management and oversight, on the other.

This article distinguishes reputation risk from reputation, places reputation risk into historical context, dissects the ill-fated launch of the Samsung Galaxy Note 7 in 2016 (a case of product safety and quality reputation risk) and concludes with specific qualitative and quantitative reputation risk management tools for leaders and their organisations to consider.

Why do all this? Because properly understanding reputation risk equips organisations and their leaders (C-suite and board) with three critical business tools: ■ Understanding the impact of their most important risks on their key stakeholders and their expectations ■ Blending reputation risk considerations (which have both positive value creation and negative value loss potential) into business planning and strategy ■ Building long-term organisational resilience and the ability to crisis manage effectively 136 Ethical Boardroom | Winter 2017

Dr Andrea Bonime-Blanc Chief Executive Officer and Founder of GEC Risk Advisory

v reputation risk: 2 Reputation The reputation iceberg

Reputation risk is a relatively new concept (about 10 years old – see 3 below) that is only partly related to reputation management, a well-known concept tied to the traditional arts of public relations and image and brand management. Here is the working definition of reputation risk from my 2014 book The Reputation Risk Handbook: “Reputation risk is an amplifier risk that layers on or attaches to other risks – especially ESG (environment, social & governance) risks – adding negative or positive implications to the materiality, duration or expansion of the other risks on the affected organisation, person, product or service.”1 Reputation risk is thus more closely related to the concepts of enterprise risk management (ERM) – the domain of management and the C-suite – and strategic risk governance (SRG)

– the domain of the board. Viewed from the ERM standpoint, reputation risk is cross- disciplinary as it can touch almost any other risk, amplifying it for better or for worse, depending on how well an organisation identifies, mitigates and manages that risk as part of its ERM system and business strategy (see The Reputation Iceberg, below).

Because most organisations still think of reputation risk as a PR concept, they are either not dealing with it or are only touching the tip of that iceberg, i.e. using the traditional concept of reputation management as PR and not delving into the deeper risk and stakeholder expectations analyses that are necessary to protect and add value to the organisation.

The Reputation Iceberg shows how reputation management is the outward-facing domain of PR and brand management while reputation risk management and oversight is internal – managed by a cross-section of inter-disciplinary experts, integrated into strategy by the executive team and considered as part of strategic risk governance at the board level. Some of the key questions that need to be asked include:

THE REPUTATION ICEBERG Outside facing Inside facing

Reputation management: Public and stakeholder relations Strategic risk governance Reputation risk management Enterprise risk management

©GEC Risk Advisory LLC 2017.

All rights reserved.

All Risks

PR & external affairs The board C-suite & exec management ERM & cross-disciplinary team

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Reputation | Risk Management ■ Does the company understand its principal risks?

■ If so, has it prepared appropriate programmes, policies, controls and resolution teams to deal with those risks?

■ Has reputation risk analysis been applied to the most salient risks (including strategic risks to report to the board) emanating from the ERM process?

■ Have we integrated risk management into strategy and surfaced the primary strategic risks to the C-suite and the board through effective ERM and strategic risk governance?

This is the essence of effective qualitative reputation risk management.

risk in 3 Reputation historical context

Let’s now place the concepts of ‘reputation’ and ‘reputation risk’ in historical context to understand how, when and why the latter rose in prominence. Here is a brief history divided into five phases (see graphic below): a) Reputation 1.0 – the Socratic definition (400 BC through mid-20th century) Reputation as a concept emerges more than 2,000 years ago, and is nicely encapsulated

by Socrates as follows: “Regard your good name as the richest jewel you can possibly be possessed of – for credit is like fire; when once you have kindled it you may easily preserve it, but if you once extinguish it, you will find it an arduous task to rekindle it again. The way to a good reputation is to endeavour to be what you desire to appear.”2 b) Reputation 2.0 – the rise of brand and public relations (circa 1950-2000) Fast-forwarding 5,950 years to the mid-20th century, we witness the rise of brand management, television and mass advertising, of Madison Avenue and the art of public relations. As Warren Buffet famously said during this period: “It takes 20 years to build a reputation and five minutes to ruin it.”. c) Reputation 3.0 – the evolution of brand and reputation metrics (1990s through to today) As the concept of brand matures and the role of public relations and marketing grows, we see an evolution in brand management to

something that includes metrics, measurement and rankings, including, for example, the RepTrak metrics developed by the Reputation Institute to measure the reputation of companies, countries and other entities. d) Reputation risk 1.0 – The ‘risk of risks’ is born (early 2000s through 2016/2017) Enter ‘reputation risk’ as a concept in the early 2000s. Prescient as always, the Economist Intelligence Unit nailed it in its 2007 report, calling reputation risk the ‘risk of risks’.

And with that a new wing of inquiry arose.

By 2013, a couple of professional services firms published surveys showing that reputation risk had become one of the top five to 10 strategic risks boards and executives were concerned about. And why suddenly? Simply put: the birth and viral global spread of social media where anyone can say anything about anyone – good, bad or ugly, false, true or otherwise.3 e) Reputation risk 2.0 – the battle to quantify reputation risk begins (2016/2017) In response to the age-old business imperative that ‘you can’t manage what you can’t measure’ as well as regulatory pressures (mainly in the EU focussed on the financial sector), some reputation risk quantification efforts have now begun in earnest, including by reputation metrics pioneer, Dr Leonard J. Ponzi, together with this author. Some of the key concepts we have been developing include: 4 ■ Stakeholder reputation studies – research studies that are based on a variety of stakeholder respondents that rate a company on customised reputation attributes mapped to specific risks ■ Media studies – a media-tracking tool is used to build the model in terms of the likelihood and impact of reputation risk events.

Other questions asked: ■ What is the total value of reputation risk to our company?

■ For each specific risk or event, what is the reputation value at risk?

■ What should be our budget for mitigating a risk?

■ What is the ROI?

REPUTATION & REPUTATION RISK: A BRIEF HISTORY TV/Madison Avenue Reputation 1.0 4000 BC-1950

Reputation 2.0 1950-2000

Reputation 3.0 2000

?

Reputation risk 1.0 2007

Reputation risk 2.0 2017

?

Internet & social media www.ethicalboardroom.com

Global brands metrics

Big data, AI & robotics

©GEC Risk Advisory LLC 2016. All rights reserved.

While these quantitative reputation risk assessment efforts are still in their early stages and are not necessarily a science (at least not yet), they represent increasingly disciplined methodological approaches which, combined with qualitative reputation risk management can provide companies a robust tool to manage reputation risk. With the emergence of more sophisticated forms of data analytics and artificial intelligence happening as we speak, these efforts may lead to something heretofore considered impossible. Stay tuned.

reputation risk 4 Better management and

oversight: lessons from Samsung Galaxy Note 7

Most readers of this article will be familiar with the Samsung Galaxy 7 Note new product release crisis that occurred in the late summer of 2016, which led, after several missteps and deepening quality and safety concerns, to a complete product recall.

Within a couple of weeks of the new product launch, several cases of product quality defects (resulting in small explosions and fires) became known. Samsung initially appeared to manage the crisis and PR aspects of the crisis relatively well. But then things went wrong, very wrong. The new product was completely withdrawn from the market, after a series of stumbles by the company that seriously affected its reputation in the marketplace as well as beginning to have serious financial consequences.

At the time of writing, the latest information available was that Nomura Securities estimated that the decision to ditch the Note 7 would cost Samsung $9.5billion in sales and put a $5.1billion dent in profit between October and the end 2017.5 Applying reputation risk 2.0 to the Samsung case: lessons for the C-suite and the board How would effective reputation risk management have helped in this situation? While we can only speculate whether some of these measures took place within the company, we can suggest that the following would constitute elements of an effective reputation risk management strategy: ■ Enterprise risk management First, an extensive and effective ERM system would be in place to determine all the relevant risks that a company like Samsung faces. Product quality and product safety risks would have to be high on the risk register and would have to be identified as key risks for which necessary and desirable policies, controls and procedures (including product defect reporting and testing) would be in place. Additionally, effective ERM can only exist in an environment of c-suite and board support Winter 2017 | Ethical Boardroom 137

Risk Management | Reputation ■ Stakeholder analysis Second, Samsung would also need to have a keen understanding of who its key stakeholders are. In this case, those with an important stake in the proper and safe operation of a consumer product, such as the Galaxy Note, would include costumers, dealers, the regulator, airlines and the flying public (many airlines forbade the carrying of this Samsung phone product on their flights for several months during this critical period) ■ Qualitative reputation risk assessment Third, Samsung would have conducted some form of qualitative reputation risk assessment, including crisis scenario planning, risk brainstorming and other exercises, to evaluate the consequences of risk gone wrong, including impacts on the expectations of their key stakeholders.

One could only expect that product safety would have been a key topic of concern and analysis in terms of its possible impact on the consumer ■ Cross-disciplinary risk and crisis teams Fourth, coordinated cross-disciplinary risk management and crisis management teams need to be at all times deployed within a company ■ Quantitative reputation risk assessment Fifth (and this is where the 2.0 part of

It is time for boards and executives to wake up to the fact that reputation risk management and oversight are not about reputation management

AN EXCERPT FROM TABLE 7 IN THE REPUTATION RISK HANDBOOK Element

All employees

Supervisors

Executives

CEO

Board

1. Risk programme 2. Assessment & monitoring 3. Knowledgeable resources 4. Cross-functional approach 5. Front line integration 6. PR & communications integration 7. Clear policies & guidelines ■ = Material/leadership responsibility ■ = Awareness/knowledge responsibility

reputation risk 2.0 comes in), a highly evolved and responsible company will also undertake the additional, periodic step of assessing its reputation risk from a more quantitative and metrics-based standpoint6 To underscore our analysis of the Samsung case above, below is a chart from RepRisk AG of the key ESG issues (from its ESG issue identification list), showing how, since 2012, Samsung has had serious risks identified through systematic data analytics of media and social media for the risks we identified above: see, under ‘Employee Relations’ – ‘Occupational Health & Safety Issues’ and under ‘Cross-Cutting Issues – Products [Health and Environmental Issues]’. See the ESG Issues Heat Map below).

Finally, Table 7 above is an excerpt from a ‘reputation risk management toolkit’, from The Reputation Risk Handbook, showing some of the 15 risk assessment related measures that

■ = Substantial responsibility ■ = Little or no responsibility

are part of a robust ERM and qualitative reputation risk management strategy.7

Conclusion

It is time for boards and executives to wake up to the fact that reputation risk management and oversight are not solely about reputation management and instead require a more systematic approach that is part integration into ERM, part integration into business planning and strategy and part strategic risk governance – an essential board role and responsibility.

Until boards and CEOs require and support these measures, reputation risk management will continue to be an afterthought at best or part of the vicissitudes of crisis and PR management at worst instead of a tool to create smarter business and strategic planning and value creation. Companies that get this will have a competitive advantage in more ways than one.

Footnotes will be published in full online

ESG ISSUES HEAT MAP FOR SAMSUNG FOR THE LAST TWO YEARS (25.11.14-25.11.16) Environmental Environmental footprint

Social Community relations

Governance Corporate governance

Global pollution (including climate change and GHG emissions)

Human rights abuses, corporate complicity

Forced labour

Corruption, bribery, extortion, money laundering

Local pollution

Impacts on communities

Child labour

Executive compensation issues

Impact on ecosystems and landscapes

Local participation issues

Freedom of association and collective bargaining

Misleading communication e.g. “greenwashing”

Overuse and wasting of resources

Social discrimination

Discrimination in employment

Fraud

Waste issues

Occupational health and safety issues

Tax evasion

Animal mistreatment

Poor empolyment conditions

Tax optimisation

Employee relations

Anti-competitive practices Cross-cutting issues: Always in combination with one of the ESG issues above Controversial products and services Products (health and environmental issues) Violation of international standards Violation of national legislation Supply chain issues ©RepRisk AG

138 Ethical Boardroom | Winter 2017

■ Low risk

■ Medium risk

■ High risk

■ Very high risk www.ethicalboardroom.com

Board surveys around the world indicate growing dissatisfaction with traditional internal audit and ERM methods and tools.

Find out why boards arenâ&#x20AC;&#x2122;t getting what they need and what to do about it. www.riskoversightsolutions.com

A better response to risk

Risk Management | Cybersecurity

Getting to grips with New York’s cybersecurity compliance rules With proposed regulations requiring organisations to have extensive cybersecurity protections in place, now is the time for getting prepared Boards of directors must actively oversee cybersecurity, with the chairman or senior officer certifying compliance, according to a new regulation in New York that will impact companies worldwide.

The cybersecurity threat to companies is ubiquitous and no industry or region is immune.

Recognising the seriousness of this risk, the New York Department of Financial Services (NYDFS) developed proposed Cybersecurity Requirements for Financial Services Companies (the ‘cybersecurity regulations’) that come into effect on 1 March 2017.

The new law, the first of its kind, contains multiple requirements for direct board involvement in cybersecurity of companies regulated by the NYDFS (covered entities) in addition to those companies that are third-party service providers for covered entities. Specifically, the board is required to take responsibility for

Shawn E. Tuma

Cybersecurity & Data Privacy Partner, Scheef & Stone the overall cybersecurity programme, review and approve its company’s cybersecurity policy, obtain cybersecurity reports from the chief information security officer at least annually and either the board’s chairman or a senior officer must sign a written certification of compliance with the regulations on an annual basis. Those who sign off on these certifications and their companies, must take these seriously as the NYDFS has very broad authority to investigate both civil and criminal matters that fall within its scope of authority.

Overview of the cybersecurity regulations

The NYDFS’s goal was to promote the protection of customer information and the information technology systems of businesses by establishing certain minimum standards for business to adhere to but not be

overly prescriptive so that cybersecurity programmes can match the relevant risks and keep pace with technological advances. This is directed at protecting companies’ information systems and non-public information, both of which are specifically defined.

The cybersecurity regulations do this by focussing on three key goals that cybersecurity experts have regularly identified as being crucial to improving businesses’ cybersecurity posture. They provide an outline of essential minimum standards for businesses to implement, designate who in the organisation should be appointed to lead the process and mandate top down buy-in to the process by management and the board of directors.

In general, they require three key things:

1

Each company must assess its specific risk profile and design a programme that addresses its risks in a robust fashion, develop policies, procedures and training for personnel to address such risks and respond to incidents Each company must designate a qualified individual to serve as its chief information

2

NEW YORK CYBER RULES The State will enforce regulations from 1 March 2017

140 Ethical Boardroom | Winter 2017

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Cybersecurity | Risk Management

security officer, responsible for overseeing and implementing its cybersecurity programme, reporting on its cybersecurity programme and notifying the NYDFS of any material incidents Each company’s senior management must be responsible for its cybersecurity programme and file an annual certification, confirming compliance with the cybersecurity regulations or certify that it meets the criteria to be exempt

3

The NYDFS designed the regulations to establish minimum standards for companies while not being overly prescriptive so that cybersecurity can remain flexible to match the relevant risks and keep pace with technological advances. These general objectives are accomplished through specific requirements designed to improve companies’ cybersecurity through a combination of technological policy-driven measures.

Though this list is not exhaustive, here are some of the specific requirements that are addressed: data governance and classification, access controls and identity management, systems and network security, penetration testing and vulnerability assessments, audit trail systems, access privileges, application security, adequate cybersecurity professionals, multi-factor authentication, data retention policies, training and monitoring of authorised users and encryption of non-public information, both in transit and at rest.

Global impact of cybersecurity regulations

Businesses in all industries across the US and abroad will likely be impacted by the regulations, despite being a product of New York law directed at businesses regulated by the Department of Financial Services. There are two reasons for this. First, the vast breadth of businesses that fall within the NYDFS’ authority includes financial services-related

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businesses in New York. Second, the cybersecurity regulations require that such businesses contractually obligate third parties that they do business with to comply with provisions of the cybersecurity regulations.

Because so many companies do business with companies related to the New York financial services industry, the reach will be global.

The mission of the NYDFS is “[to] reform the regulation of financial services in New York to keep pace with the rapid and dynamic

The reach of the NYDFS cybersecurity regulations will expand far beyond the companies that it directly regulates to include, to a certain degree, those companies that do business with them evolution of these industries, to guard against financial crises and to protect consumers and markets from fraud”. It does this through its authority to take any actions necessary to: ■ Foster the growth of the financial industry in New York and spur state economic development through judicious regulation and vigilant supervision ■ Ensure the continued solvency, safety, soundness and prudent conduct of the providers of financial products and services ■ Ensure fair, timely and equitable fulfilment of the financial obligations of such providers ■ Protect users of financial products and services from financially impaired or insolvent providers of such services ■ Encourage high standards of honesty, transparency, fair business practices and public responsibility ■ Eliminate financial fraud, other criminal abuse and unethical conduct in the industry

■ Educate and protect users of financial products and services and ensure that users are provided with timely and understandable information to make responsible decisions about financial products and services By requiring adequate cybersecurity safeguards for companies that play a role in the financial services industry, the NYDFS is fulfilling multiple aspects of its policy objectives.

Impact on companies that are directly regulated by the NYDFS The NYDFS cybersecurity regulations apply to what they define as covered entities.

“Covered entity means any person operating under or required to operate under a licence, registration, charter, certificate, permit, accreditation or similar authorisation under the banking law, the insurance law or the financial services law. Put simply, a covered entity is any entity regulated by the NYDFS.” The NYDFS’ reach is expansive in looking only at the companies that it regulates directly. As expected, this includes banks and trust companies, credit unions, foreign bank branches, licensed lenders, health insurers, life insurance companies, property and casualty insurance companies and savings and loan associations. There are many more companies that may not be so easily expected: ■ ■ ■ ■ ■ ■ ■ ■

Bail bond agents Budget planners Charitable foundations Cheque cashers Holding companies Investment companies Money transmitters Service contract providers (“[Any] person or entity who sells or administers a service contract and who is contractually obligated to provide service under the service contract”).

Winter 2017 | Ethical Boardroom 141

Risk Management | Cybersecurity The last one – service contract providers – is extremely expansive and has the potential to pull many companies within the scope of being directly regulated by the NYDFS without those companies fully appreciating the implications.

Covered entities that meet the following criteria are exempted from some of the requirements of the regulations, although most are still required: ■ Have fewer than 10 employees, including any independent contractors ■ Have less than $5million in gross revenue in each of the last three fiscal years ■ Have less than $10million in year-end assets - these entities are exempted from some, but not all, requirements of the regulations

Impact on companies that are indirectly regulated — third-party service providers to covered entities

The reach of the NYDFS’ cybersecurity regulations will expand far beyond the companies that it directly regulates to include, to a certain degree, those companies that do business with them. Section 500.11 of the Regulations specifically addresses the cybersecurity of such third parties and requires covered entities to obtain satisfactory assurances that those they do business with have adequate cybersecurity safeguards.

When thinking about one of the objectives of the cybersecurity regulations, as well as most other cybersecurity and privacy policies and frameworks, it is to protect the confidentiality, integrity and accessibility of the information and computer systems. This requires protecting the information always, wherever it may be and with whoever may have possession of it. This also requires having protections in place for all systems that will interact with the covered entity’s network. By implementing these third-party requirements, the NYDFS is trying to ensure that a covered entity’s information is protected the same way by third parties who may receive the information is it is when it is in the custody of the covered entity. This is the same method that is used under HIPAA (Health Insurance Portability and Accountability Act of 1996) for protecting health information that is transferred from a covered entity under that framework to a business associate. Essentially, this means that third-party business partners are becoming business associates.

The cybersecurity regulations decree that a covered entity’s chief information security officer requires the third-party service provider to maintain a cybersecurity programme that meets the requirements of the cybersecurity regulations. It further requires the covered entity to implement written policies and procedures designed to ensure the security of information 142 Ethical Boardroom | Winter 2017

systems and non-public information that are accessible to, or held by, third parties doing business with the covered entity.

The regulations make it a requirement for their contracts via contractual provisions and/or guidelines addressing cybersecurity.

They do not include an exception from some of the requirements for smaller third-party service providers, like those for smaller covered entities.

What do the cybersecurity regulations mean for all companies?

Many businesses already have relatively mature cybersecurity programmes in place and for those businesses the cybersecurity regulations may not have too great of an impact. Many businesses, however, do not have such programmes and are lost in the wilderness of confusion in determining what they should be doing and how they should be doing it. For those

regulated entities and have access to or hold non-public information of covered entities or their information systems (third-party service providers) will be subject to certain mandatory requirements to ensure the covered entities’ non-public information and information systems remain adequately protected. Covered entities will be required to develop preferred contract provisions for such third-party service providers that permit the covered entity to assess their cybersecurity posture, require they implement specific cybersecurity measures to protect the non-public information and information systems, establish notification and remediation requirements in case of a cybersecurity incident, and allocate who pays the costs for such an incident.

The substantive requirements of these contracts will have little room for negotiation because they are being pushed down by the requirements of the law. Moreover, because these contractual protections are to protect DATA IMPLICATIONS Protections must be in place for all systems that interact with a network

businesses, the regulations should provide a basic guide to help them develop and implement an appropriate cybersecurity programme.

The regulations were released on 13 September 2016 in an non-finalised form, subject to public comment, with an initial effective date of 1 January 2017. Given the substantial feedback that was generated, they were revised significantly and re-released on 28 December 2016. Businesses should anticipate that they will be codified in substantially similar form as they are now and prepare accordingly.

The effective date was delayed to 1 March 2017, but businesses that are directly regulated by the NYDFS must begin preparing now so that they will comply with the regulations by the time the law goes into effect. Non-NYDFS regulated businesses that do business with

the non-public information and information systems, they must flow along with such data and systems access and be pushed down to other contractors and sub-contractors who have such access.

Businesses that may find themselves in this situation need to have an adequate understanding of these requirements so that they can differentiate between those things the covered entity must do vis-à-vis those things it wishes to do when negotiating these contracts.

They also need to begin preparing so that they will have appropriate cybersecurity measures in place to satisfy the requirements of the cybersecurity regulations that are passed along to them via contract and that they must then pass along to those with whom they do business where the covered entity’s sensitive personal information is being shared. www.ethicalboardroom.com

WHEN CYBERSECURITY

DELVES BENEATH THE SURFACE,

APPEARANCES WON’T DECEIVE YOU.

There’s no test, software or process that can ensure absolute security. But with the right partner and an approach that fits your company, you can be confident you’ve taken all the right precautions. At Protiviti, we’ll collaborate with you to put in place technology, people and processes that protect the areas of your business that matter most.

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Risk Management | Politics & Business

Charles Hecker & Jonathan Wood

Charles is a Senior Partner, Jonathan is the Director of Global Risk Analysis, Control Risks

Forecasting and responding to geopolitical risk in 2017 Brexit, the US election and more — the year ahead will be one of the toughest for directors to make the best decisions for their companies If only boardrooms had periscopes. What a great way to see what’s coming. Oh, wait.

The board is supposed to be a company’s periscope, isn’t it? OK, let’s try again. If only boardrooms had crystal balls. Regrettably, at a time when they would be more useful than ever, crystal balls are in their usual short supply.

Fear not. You are right to think that 2017 will bring political and economic uncertainty but, crystal ball or not, we still have the tools to examine what the future brings and how companies should prepare themselves.

144 Ethical Boardroom | Winter 2017

International companies will experience different levels of risk in the coming year, depending on their business models, their global footprints, the length of their supply chains and a host of other factors. Events in 2017 will affect all of us differently. Still, every company and boardroom should keep in mind an important set of looming risks – some carried over from the current year.

Globalisation and its discontents It is premature to say that globalisation has shifted into tyre-burning reverse.

The expansion of the global economy to the world’s most distant outposts is, however, in a deep shudder. The election of an economic nationalist to the Oval Office will keep it in that agitated state for some time to come.

This poses a series of important risks in the spheres of politics and commerce.

Monitor carefully the relationship between the US and China. Over the years, economic interdependence has kept a lid on periodic China-US tensions, preventing small incidents from escalating into major conflicts. As a Trump presidency places pressure on the economic ties between the US and China, watch the political sparks fly. It remains to be seen whether those sparks will ignite a security incident. The likelihood of a severe escalation is, however, relatively low.

A Trump administration will not impose a threatened 45 per cent tariff on imported Chinese goods. Economic reality knows how impractical, not to mention destructive, that would be. Short of that, though, Washington www.ethicalboardroom.com

Politics & Business | Risk Management LOOMING RISKS Boardrooms face uncertainty in 2017 and need to be prepared

could significantly change the optics of the relationship with Beijing. Economic relationships across a host of sectors will become the subject of elevated tension.

Remember, a Trump White House is not the only source of global indignation. Like his Washington counterpart, Chinese President Xi Jinping also feels that the global economic system – China joined the WTO in 2001 – has placed a tiresome yoke around his country.

Of course, China and the US are not the only players in the globalised economy, but they are the biggest. In Asia, more broadly, the anticipated US withdrawal from the Trans Pacific Partnership (TPP) threatens to redraw the commercial map of trans-Pacific trade. A move towards economic nationalism would jeopardise the US position in trading blocs and in bilateral negotiations with partners, such as Mexico and the EU, though the latter is now busier absorbing self-inflicted wounds than external shocks.

The EU and Brexit

The UK’s exit from the EU will probably start later than the March 2017 date Prime Minister Theresa May has trumpeted. Once that process does begin, it will take far greater effort on behalf of the British government than proponents claim. The real challenges are on the other side of the English Channel. www.ethicalboardroom.com

In 2017, the EU will continue to grapple with an unmanageable refugee crisis.

Tackling Greece’s debt and reform challenges remain beyond its capabilities. Temporary suspensions to the Schengen Agreement are rapidly ossifying. The Italian referendum on legislative procedures in December 2016 will have merely been a warm-up act for elections in France (non à Le Pen) and Germany (noch ein Mal for Merkel).

Right and left-wing anti-EU groups will whip themselves into a populist frenzy, but will not rend the EU asunder. Short of that, though, there is no shortage of areas of concern.

Moscow calling

Do not believe the hype of a bromance between Trump and Russian President Vladimir Putin.

It never existed and may never come to pass.

But, as the TV advert from the phone company

Events in 2017 will affect all of us differently. Still, every company and boardroom should keep in mind an important set of looming risks — some carried over from the current year

likes to say, “It’s good to talk”. Putin was one of the first world leaders to call to congratulate President-elect Trump and the two of them apparently admitted that their countries’ deplorable relationship needed work.

To be sure, some of the heat will come out of the dialogue between Moscow and Washington. You will not hear Trump criticise Putin for his domestic or, even, international behaviour. Spare a thought here for Ukraine, if you will. A serious rapprochement between Moscow and Washington could come at Kiev’s expense.

Putin will push for Trump either to recognise the annexation of Crimea or to stop forcing peace negotiations.

But Russia remains one of the US’s foreign policy and military establishment’s most beloved demons. That hostility will likely dampen some of the passion in Trump’s so-far rhetorical embrace of Putin. That same establishment – not to mention the organisation’s 27 other members – will also limit Trump’s ability to inflict much damage on NATO (though Trump’s criticisms of the alliance will be music to Putin’s ears).

Sanctions will remain a political football for the year to come. If relief comes, it will be toward the end of the year and will come first from the US. The EU may follow with limited sanctions relief later.

Winter 2017 | Ethical Boardroom 145

Risk Management | Politics & Business Syria will be a significant and early test of the relationship between Russia and the US. The two countries will profess to work together on counter-terrorism issues.

Reconciling their differences on the status of President Bashar al-Assad, however, will keep the two from a meaningful meeting of minds on the Middle East.

Terrorism in turmoil

The coming year will see Islamic State (IS) come under near debilitating pressure in Iraq and Syria. The organisation will no longer be able to finance its activities, recruit militants or wage attacks in the way it has since its creation as a breakaway from al-Qaida in 1999.

Instead of a strong centralised presence in Syria and Iraq, IS will now have a diaspora.

This fragmentation – not to mention the ongoing activities of al-Qaida – will pose a more dispersed terrorist threat in 2017.

Moreover, Islamist extremists are only part of the emerging terrorist landscape. Domestic radicalisation – something that breeds quietly in suburban climes and is difficult to detect – will become a more prominent threat in 2017. This threat will emerge from sympathisers with rebels in the Middle East, but also from lone wolves with individual and independent agendas.

This last category is the primary source of the ‘active shooter’ – the gunman who terrorises his workplace from within, often without warning signs.

You will not need a bodyguard for a business trip to Paris. Armoured cars are not required to traverse the streets of Brussels. But these sorts of concerns – particularly in combination with the active shooter phenomenon – are transforming the concept of a company’s duty of care.

Organisations that do not re-examine their programmes for crisis prevention and impact mitigation will be seen as falling short of best practice.

Regulate this

We have grown accustomed to the proliferation of regulation. We have also, more recently, grown accustomed to its weaponisation. The propagation of regulation from country to country and sector to sector is genuinely a growth industry.

Or is it? Another source of uncertainty for 2017 is the potential trajectory of the US and, by extension, the global regulatory climate. Armed with the razor-sharp ink nib of the executive order, the White House is poised to scratch a raft of regulations and may even put paid to entire regulatory agencies. The US’s adherence to the Paris climate accords is in question. The Dodd-Frank Act, the legislation the financial services sector loves to hate and even the Foreign Corrupt Practices Act may be modified, gutted or scrapped. Candidate Trump called the FCPA a ‘horrible’ law that ‘should be changed’.

The newest regulatory frontier is, as ever, 146 Ethical Boardroom | Winter 2017

in cyberspace and the universe of big data.

There, contrary to the laws of nature, the universe may actually be contracting. The world of regulation is not.

Cyber that

As globalisation shudders, so the world of cyber quakes: economic nationalism has an evil twin – data nationalism. International accords in cyberspace were never easy to come by and in 2017 they will be even harder to strike. In their stead, we will have piecemeal legislation as nation-states seek to protect their own agendas on the storing and transfer of data. The casualties will include international companies, who will no longer be able to manage their electronic assets uniformly or consistently across borders. E-commerce may suffer. Data protection compliance will almost certainly become considerably more expensive.

Organisations that do not re-examine their programmes for crisis prevention and impact mitigation will be seen as falling short of best practice

National-level regulations will also spike in anticipation of a world more penetrated by cyber espionage. Some nations will focus on penetrating others’ systems for the commercial jewels they harbour. Others will play politics and seek to influence political processes to their advantage. Both types of activity pose an equally significant threat.

What’s a board to do?

Just as companies experience risk differently, so they respond differently, too. The current landscape will likely produce at least three different corporate responses – the ark, the shark and the whale.

Arks will pull up the oars and assume a defensive posture, focussing on core businesses and markets. Non-performing assets, debt and excess costs will all go. Expansion moves to the bottom of the to-do list. Some companies will become arks voluntarily – they don’t like what’s coming in on the tide and they act

accordingly. Others will be made into arks by external shocks, regulation or strategy failures.

Arks can also be victims of an increasingly complex and competitive global business environment. Being called an ark may not sound like flattery. Don’t worry. These companies may be best poised to rebound when external variables improve.

Sharks will be sharks – they will cruise on the hunt for risk and opportunity, either in new activities or new markets. Low (and even negative) interest rates have increased the urgency and decreased the costs of hunting yield. Economic reforms and relaxed sanctions regimes (see Cuba, Myanmar and, well, maybe Iran) have made once verboten markets more attractive. Companies with a healthy risk appetite – and the risk management practices to support that appetite – will look for opportunity in those and other markets. Finally,

MANAGING RISK Will your business be an ark, shark or whale in 2017?

growing middle classes continue to present the opportunity for risk-adjusted returns that beat anything on offer in the core economies.

Whales will try to get too big and too diverse to sink in anticipation of a prolonged period of strategic uncertainty. Taking advantage of cash stockpiles (around $6trillion at the outset of 2016) and historically cheap financing (buffered by the ‘lower for longer’ mantra of global central banks), this strategy focusses on mergers and acquisitions to create diverse, integrated businesses that can dominate select markets or sectors.

Whales want to compete and operate globally as new markets emerge on the back of rising incomes or better technology. Though being a whale pays some immediate dividends in terms of revenue, market share and efficiency, it is fundamentally a long-term strategy, increasing resilience to risk and competition while targeting underlying trends in consumption, demographics and technology. www.ethicalboardroom.com

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