In early February, the Hayne Royal Commission delivered its report on misconduct within Australia’s financial sector. The Report named corporate boards of directors and senior management as the parties responsible for ethical lapses and business misconduct, and noted the interplay between the two as the crucial weakness point.
To overcome organisational culture failings, the Report stated the board must interrogate management, and senior management must provide the right information to the board to facilitate this accountability. Though the terms of reference for the Hayne Royal Commission were focused on the Australian financial sector, it’s important to also consider the relevance of the renewed focus on organisational governance and oversight to the broader corporate sector.
A number of the eight recently-released Australian Stock Exchange Corporate Governance Council (ASX CGC) Corporate Governance Principles and Recommendations align with Hayne’s recommendations, including an obligation on companies to instill a culture of acting lawfully, ethically and responsibly; recognise and manage risk; and lay solid foundations for management and oversight. The Australian Institute of Company Directors also agrees that “Ethical decision making sits at the heart of director practice. Boards must set the tone that misconduct is dealt with swiftly and visibly”.
When it comes to “senior management,” there are many accountable C-suite parties. Among them are the chief executive officer (CEO), chief financial officer (CFO), and the leader of the corporate law department: the chief legal officer (CLO) or general counsel (GC).
As boards look to ensure compliance and companies look to assure a strong, ethical corporate culture, the CLO or GC has a crucial role. Within the GC position, ethics, compliance, the law, and risk all come together. As such, he or she is uniquely qualified to spot risks before they become true misconduct – helping companies to maintain a strong ethical foundation.
GC as a board ally
In all contexts, lawyers advise clients. For the GC, this client is the company. It’s not one department, it’s not a particular officer or employee, and it’s certainly not the CEO. His or her fiduciary duty is to the company. A director’s mandate is the same. Their duty is to the company alone.
With these interests aligned, the GC is a crucial ally to the board. It is the GC who spots possible ethical quandaries before they happen, who advises the company on compliance, and who can ensure that risk is taken into consideration at every step of the way. In the Hayne Report’s recommended cycle of (1) the board challenging management and (2) management providing the necessary information to the board, we assert that a third step is ensuring the GC has clear, direct access to the CEO and to corporate directors.
Effectiveness in the GC role
To be effective – to spot issues and risks – and then to elevate their importance, the GC needs to be well-positioned. He or she must have the access needed to become aware of any potentially risk-fraught company plans, then have the ability to discuss the risks with key company decision makers.
First, he or she should report to the CEO. This way, there are no intermediaries blocking access to the company’s top leader. This reporting structure also sends the message to all employees and stakeholders that ethics and compliance are important to the company. The GC has the CEO’s ear on these matters.
Surprisingly, in Association of Corporate Counsel (ACC) research on this topic, we’ve tracked that just under eight in 10 companies worldwide use this reporting structure for their CLO. The 2019 ACC CLO Survey, which includes insights from more than 1,600 CLOs in 55 countries, revealed that only 78 percent of GCs enjoy a direct reporting relationship to the CEO. Among respondents from Australia and the Asia Pacific region, this figure drops slightly, to 75 percent. This means that only three out of every four companies follow the governance best practice of having the GC report to the CEO. One in four does not, opening itself up to possible blindsides when it comes to questions of compliance.
Second, the GC needs to have a strong relationship with the board of directors. This ensures alignment in the company’s prioritisation of ethics and compliance. These crucial issues are addressed at board meetings, so ACC also tracks whether the GC or CLO is present at meetings of the board of directors. Just over two-thirds (68 percent) of all GCs who responded to the 2019 ACC CLO Survey state that they regularly attend these meetings of the board of directors at which key ethical and compliance issues will be discussed.
Notably, ACC tracked a correlation between these two indicators of a GC’s effectiveness. A GC or CLO who reports directly to the CEO is much more likely to “almost always” attend board meetings versus those who do not report to the CEO (75 percent versus 46 percent). In the case of the Hayne Royal Commission, which points out the disconnect between the information the board knows and what the board should know when it comes to risk, it is unwise not to have the GC or CLO present at the board meetings.
We tracked similar figures when measuring how the CLO is viewed by fellow members of the C-suite. While 76 percent of all CLOs who report to the CEO stated that they are “often sought by the executive team for input on business decisions,” only 48 percent who do not report to the CEO answered affirmatively. Similarly, 79 percent of CLOs who report directly to CEOs say they “frequently meet with business leaders to discuss operational issues and risk areas,” compared to 62 percent who do not enjoy a direct reporting line to the CEO. This drop off could very well be the difference between a crisis averted and a crisis exploding.
A “seat at the table”
It certainly makes sense. Those who report to the CEO have more influence within the organisation. A CLO who reports to the CEO will have a “seat at the table” when it comes to executive team debates, boardroom discussions, and other events that shape a company’s strategic direction. With this ability to communicate risk to the CEO, C-level peers, and the board, the CLO also gives these leaders the information they need: a better understanding of how risk will affect the company. This is exactly what the Hayne Report said needs to happen more often. As written in the Report, “the evidence before the Commission showed that too often, boards did not get the right information about emerging non-financial risks … and did not do enough with the information they had to oversee and challenge management’s approach to these risks.”
With a more open dialogue, which is permitted through open access to the CEO, the GC will be able to provide better strategic advice, helping the company to mitigate risk and make strong business decisions that put ethics and compliance first.
Even outside of Australia and beyond the shadow of the Hayne Royal Commission, the need for a “seat at the table” is palpable. In Europe, the Danske Bank money laundering scandal may well have been prevented if the GC had the ability to communicate ethical lapses directly to the CEO. In 2012, Danske Bank’s GC had his reporting line redirected from the CEO to the CFO. In 2014, Danske in-house lawyers urged an internal investigation into whistleblowing investigations. Other senior executives overruled it from happening, so a full investigation never took place. Just a few short years later, the scandal erupted. We will never know what could have been prevented if the bank followed better governance practices. But the thwarted investigations alone demonstrate why putting roadblocks between the GC and the CEO is a bad idea.
The age of the CLO
Because so many business decisions today have legal considerations, most companies realise the importance of a well-positioned chief lawyer and design their corporate reporting structure accordingly. As we’ve seen with recent headlines, the entire health of an organisation depends on strong governance and ethical leadership. But on the other hand, with one in four CLOs in Australia and Asia Pacific stating that they do no report directly to the CEO, the potential for information to “slip through the cracks” is all too real. Without direct reporting lines to the CEO or the board, the risk for miscommunication – or lack of communication – creeps in. CLOs today have gained a stronger ability than ever before to shape the company’s future through contributing their analysis of risk, legal recommendations, and strategic business advice. But without the right governance in place, the law department loses its ability to serve as a crucial ally to the board. With best practices enacted, directors and the GC can ensure the right tone from the top and a proactive approach to matters of ethics and compliance.
Tanya Khan is the Vice President and Managing Director of the Association of Corporate Counsel (ACC), www.acla.acc.com