How Corrupt Are the Banks? Corrupting Cultures.

“Rigging the system to fix their bonuses. The word “corruption” is not enough to describe what they were doing.”

 

So stated one expert observer on Radio 4’s Today programme this morning (November 12, 2014) about the Foreign Exchange corruption in the world’s banking systems. UBS, RBS, Citibank, JP Morgan and HSBC were fined $3.4bn and Barclays is still to settle.

 

The travails at Tesco on which I have recently written, appear almost trivial beside the corruption (and, yes, “corruption” is the word to describe what was happening) that pervaded the western world’s banking systems leading up to and well beyond 2007.

 

The Bank of England apparently feels exonerated by the fact that no-one there knew anything about the foreign exchange mis-dealings at the five (or six) banks now fined. Just like the protestations at Tesco’s auditors (PwC) who, after 30 years, knew nothing about the culture changes that were at the root cause of Tesco’s recent failings.

 

Culture is the root of corruption

 

Francis Fukuyama in his excellent books “Political Order and Political Decay” and “The Origins of Political Order” showed how culture is at the root of society at the national level.

 

This is as true of companies – complex adaptive systems if ever there were any – as of nations. Companies are directed entities and depend on senior management and Boards allied to the competitive and regulatory environment in which they exist for the culture that they employ. The culture of every business is different – depending on the specific people they employ, the rules they employ, the country and region they exist in and the external environment.

 

The culture of any business organization is not a secret to those working within in it and is not a secret to those who work closely with it.

 

When a culture goes bad, as it clearly did in the case of Tesco and on a much broader and deeper scale in the case of the banks, it is not sudden and evolves as a result of changes that are both internal and external. Culture change has been the topic of many books and papers since well before the advent of quality management and Deming but these books tend to dwell on how to improve the culture to one of quality control or of “excellence” (as in Tom Peters’ “7 S’s”).

 

Unfortunately, there is little literature on how to understand corrupting business cultures in order to make changes that impact early enough so that customers, the business and shareholders are not hurt. The issue with banks is that nations have been hurt as a result of the toxic atmosphere in these institutions and the noxious emissions that resulted.

 

This cultural health and safety aspect of banking is clearly not understood by regulators (nor, indeed, by Directors and Audit Committees let alone external audit firms). Regulations are all about legal change and regulators are, to a large extent, ticking and checking against a set of procedures in the same way that external auditors carry out their roles.

 

The prime aim of such regulators seems to be to do a job so that they cannot be blamed for any failures. The Bank of England – crucial to the proper oversight of our financial systems – has failed so often in the past ten years but now seems comforted that no-one inside the BoE knew what was going on. RBS’s own (relatively) new CEO (Ross McEwan) voiced his anger on the BBC at the actions of “a very small group” of foreign exchange traders ruining everything for the many good people that work for RBS. He was asked the right question by the BBC interviewer (Kamal Ahmed) – “is culture changing enough”? McEwan responded that it was not changing quickly enough. But, the bad culture became institutionalised (as Ian Fraser’s excellent “Shredded” showed)  and the thought that senior management did not know of such a culture existing within such a key area of the bank is too sad to be true.

 

Walk into any office of any organization and any seasoned business manager will detect the culture. Ask some questions and listen to the responses. Any organisation is based on how its culture works and who benefits from that cultural response to its aims and ambitions.

 

Short-termism, where bonuses are made through short-term risk-taking and often corrupt dealing, is bred in cultures that are knowable. For management to claim not to be aware is ludicrous. As many senior bankers said around 2008/9, they knew the culture was wrong but could not stop it as everyone (every bank) was the same – no-one was willing to stop.

 

Fukuyama describes well how corrupt societies work where lack of trust exists around the centre (e.g. government) and where corruption is rife. No-one is wiling to be the first to pay their proper taxes, for example, if no-one else does. The same was true with the banks – everyone was corrupt, so who was going to stop the game? No-one. Now, no-one trusts the Banks – supposedly, a central plank on which wider society floats.

 

With the foreign exchange corruption, which occurred much more recently, there seems to be little or no excuse. The banks have been going through huge structural re-assessments since they sank in 2008 and senior management were being changed along with it. The Bank of England should have been focused on critical market areas (Foreign exchange transactions in London – 40% of the world’s transactions take place here – are hardly trivial) and should not have been unaware of the overhang of a corrupt culture in UK banks. To claim otherwise is nonsense.

 

The culture within regulators has to be changed along with the banks. While no-one claims they are corrupt cultures, a culture of defensiveness, box-ticking, shifting blame and lack of knowledge is the worst cultural set for a regulator. They need (like external auditors) to be responsive to societal needs – not tick and check but pro-actively understanding the organisations they are supposed to be regulating (or auditing). This is not an easy task for organisations that appear to be completely incapable of doing this important job – not wanting to rock the boat before it sinks. But, rocking the boat may throw out those who are bent on sinking it before it sinks – that is what good regulation (or auditing) is all about.

Was Tesco Corrupt?

Corrupt = “guilty of dishonest practices”, “lacking in integrity”

Tesco is in a state of some chaos brought on by real market competition and has seen its business model threatened. It has always been a fighter – a company built on a culture that customers responded to well – a “pile ‘em high” culture that sought to bring low prices and wide choice.

This success was predicated by a market where the medium wealthy within society (middle class or in-work working class)– where most people existed – wanted good value and reliable products.

This outward superiority over the competition was managed through an internal capability highly based on staff knowing their job well, a high investment in systems that could gauge customers’ needs and supply them. To many suppliers it was a desperately competitive environment – with continuously lower prices and higher quality requirements.

How Corporate Culture can lead to Corruption

This culture was also, as far as can be seen, based on internal fear of failure – a numbers culture that relied on bullying to ensure that every day’s sales and profit figures were met. The Telegraph recently wrote on this subject where it said that: “Investigation into Tesco’s £250m profit shortfall unearths ‘corruption’ of culture.”

For any organisation, the culture employed for the business is critical but the headline suggests that the culture of Tesco indirectly led to corruption. This corruption came about, for instance, through accounting issues – the taking of discounts from suppliers too early (well before they could be guaranteed, apparently). The culture led somehow to the corruption – it seems that Tesco’s leadership was blind to the corruption (which, it is claimed, was only a set of accounting issues – where no-one directly benefitted).

This is the norm in some companies – especially in highly competitive markets where the differences between the competitors are hard to judge. In food retailing, the differences are price, range, full shelves, ease of use, location, quality and service. In 2014, most of the major retailers have products and services that are comparable. Tesco clearly believed that it was the best and that its strategy was right. That strategy included a culture that demanded much of its people. Overall, that is not a bad thing – until it becomes a culture that demands results no matter how achieved.

In my book “Last Line of Defense”, I described a business in a different market sector (aerospace and defense) that operated under similar cultural disciplines. It was in a business that was highly competitive and sales and bottom line results were critical. Senior management made demands on its staff. Having made those demands, senior management did not want to know how those demands were satisfied. They imposed a culture and required the response.

In the book, the CEO demanded that long-term accounting changes were made to turn losses into profits for a countermeasures system – the RWR-50:

“You have all made clear to me how the RWR-50 is going to establish Global as a world player in the defense business, at last living up to its name. Well, the first thing you have given me is a problem that must be dealt with to allow those prospects to be nourished and grow to maturity. I want your total support in my actions. Anyone that feels unable to live with this should be under no misapprehension: the only option would be to find alternative employment.”

For staff operating in such an environment, successfully meeting such demands often resulted (within aerospace and defense in the 1970’s until now) in corrupt practices. This included outright bribery of customers to buy their products. Many industries such as aerospace and defense, construction, energy have bad reputations for such methods of corruption.

In Tesco’s case, there is no suggestion that I have seen of any corruption such a bribery – at least not since the Potato bribery case of 2008 where Tesco’s potato buyer was paid millions of Tesco’s own money to swing purchases in one supplier’s direction.Indeed, The Grocer included an article only two years ago that suggested bribery and corruption remained a serious problem between supermarkets, wholesalers and suppliers.

However, just as the culture of the aerospace and defense industry directly led to corruption (with senior management often claiming denial of all knowledge of such impacts), so the culture in Tesco is highly likely to have led to accounting irregularities and the suspension of senior management. If these cases are shown to be true, then denial of knowledge is no different.

Indeed, the worst of the aerospace and defense companies, involved in long-term projects, have for many years developed ways to control accounting of such projects. Losses have been turned into profits – legally in many cases – as accounting for the future is indeterminate and unauditable. Notions of conservatism (supposedly the hallmark of good accounting) are thrown aside when senior management make different demands and shareholders need to see higher share prices and better dividends. This often led to accounting changes in that industry. It is no surprise that accounting issues are central to the likely problems at Tesco.

Governance and Culture

Of course, these accounting problems are an outcome of the culture. Bad management (misunderstanding changing market patterns and / or unable to resist them) relies more and more on a culture of threat and intimidation when things go bad or just tougher. Senior management then rely on the fact that they did not ask for accounting irregularities to be able to say that they had no knowledge – they are innocent (as innocent as Henry II was innocent of the murder of Thomas a Becket).

Some might also argue that no one directly benefitted from the corruption that is alleged to have existed at Tesco. This is also not the case. Accounting changes that improve stated profits have an impact on job security (no-one looks for “alternative employment” if they meet their targets), bonuses, share prices. Of course, unless the business then grows through increased demand, the accounting problems show up (as they have done at Tesco as the tide has gone out).

This is a serious issue for senior management. The Bribery Act of 2010 introduced tough requirements on senior management in cases of bribery. Where bribery and similar corruption is found in a company, senior management can no longer hide behind a veil of “no knowledge” of the bribery or corruption. It is now required that they are able to show that proper processes were in palace to ensure that such bribery and corruption were minimised or, better still, eradicated. Where it is clearly not the case, then senior management (Directors) can be held liable.

Good governance has now to be firmly enmeshed within a culture in a business as far as the Bribery Act is concerned. But, the absence of such good governance is shown in any company that has a culture of threat and intimidation that is likely to lead to pressure on staff to rig the statistics. In the Bribery Act, such a culture would be a sure sign of likely Director culpability. What is the difference within Tesco – if such accounting allegations are found to be the case? Although unlikely to be subject to the Bribery Act, the senior management culture at Tesco clearly led to a lack of due process that appears to be no less culpable. It is surprising that the Non-executive Directors and auditors also missed the clear links between bad culture and poor governance.

The pressure to make results no matter what resounds throughout a company. No one in the company could be immune from that pressure nor would they (at senior levels) be in any doubt of the repercussions that ensue. Accounting irregularities are an outcome of bad culture and bad governance. The Bribery Act has shown that senior management (the Board) has a direct responsibility for ensuring that culture must include good governance where bribery is a risk. There is a direct link between culture and governance and, where corruption exists, all senior management are normally culpable – processes should have been in place to minimise the risk of such “accounting irregularities”.

Bad culture leads to bad governance and potentially to corruption – the links are known and understood.

If the allegations are proven, then Tesco was corrupt. Probably not alone.

Go to:

Was Tesco Corrupt? – II

Governance – From Osborne to Diamond – where is it?

If we wanted to see bad governance issues at their most raw – in all sectors of society – then maybe this was the week.

First – Corporate governance was shown to be completely awry at Barclays, where Bob Diamond’s testimony showed so clearly that non-execs that should have been applying governance strictures were so out of the picture.

Second – the public sector and education, where Michael Gove in a strange speech at FASNA (Freedom and Autonomy for Schools) said he knew what “good governance” looked like (fascinating to hear a politician talk about good governance!) and criticized many existing school boards as:

A sprawling committee and proliferating sub-committees. Local worthies who see being a governor as a badge of status not a job of work. Discussions that ramble on about peripheral issues, influenced by fads and anecdote, not facts and analysis. A failure to be rigorous about performance. A failure to challenge heads forensically and also, when heads are doing a good job, support them authoritatively.

Third – charities, where governance was held up at an ACEVO (Association of Chief Executives in Voluntary Organisations) conference to be a critical problem and the split between Chief Execs and Trustees very problematical (nearly 30 are seeking urgent advice from ACEVO on this issue).

Fourth – Government via the astonishing spat between Messrs. Osborne (our Chancellor of the Exchequer) and Ed Balls (his shadow) over banking and LIBOR – or worse, their obvious hatred for each other.

Across the nation – Governance in doubt

We clearly have a crisis of governance across the nation and in all sectors. Government, public sector, corporates and Third Sector all exhibit problems where real strains are showing and proper governance is often missing.

Gove’s comments (which show political mannerisms at their worst) can be spread across all areas if we want to.

The role of non-executive directors, trustees, governors or similar is crucial in organisations. Their importance is completely under-estimated in the same way that the importance of backbenchers in Parliament is. This showed so clearly in the Osborne / Balls playground fight this week and showed how dangerous it is when the Executive is a major part of the Legislature (as we have it in the UK) and back-benchers are unable to confront the over-weaning egos of the front-benchers.

The example shown here – of a senior government minister and his shadow in opposition – was appalling but, unfortunately, does shine a light on society. When recession strikes, the worst examples of society come to light.

What’s going wrong?

Much is actually right in sectors of society that organize themselves into such oganisations such as companies, public sector bodies and Third Sector organisations. But, there is a crucial link that is not sufficiently understood and where traditional rules don’t really work anymore – and, where they do work, are rubbished by politicians pursuing a political agenda.

The link is the one between senior operational staff and Boards. It is the crucial link in any organization.

Corporates

The danger here is the risk that Chief Executive Officers who have got where they are because they are good at what they do but also because they act like steamrollers, often force Boards to concede issues with too little scrutiny. Time is of the essence and information hard to take in when you are a Non-Executive Director (NED) maybe at many corporations and spend a few days a year on each.

The law now lays a heavy burden on NED’s but there remain many who want to bring their skills and knowledge and experience to companies. Most are acceptable to the CEO if they have good connections /networks. Beyond this, they are begrudgingly provided with data and fill remuneration and audit committees and the like, fulfilling a role but often not really involved with the central and driving forces behind the business. Government tinkering with the laws has prescribed the areas of involvement that the law requires and where NED’s have to focus. Areas that are fundamental, like strategy, culture, and ethics, are more likely to be left outside.

The danger becomes real in companies like Enron – which imploded under a Ponzi scheme that should have been obvious to all on the Board. It is endangering one of our best-known banks as it did with RBS and Lloyds-TSB.

Name the major scandals in corporates and then describe the efforts of NED’s to make things right – whether in newspapers and phone hacking, oil industry and health and safety, mining and corruption.

Public Sector

I use the example of schools / academies to show the reverse. Michael Gove, in seeking to set up an array of different schools so that the good ones can “emerge”, is in danger of wrecking education and the potential for good that exists in those schools / academies.

Of course, he was speaking at the FASNA – so, was amongst friends. But, his injudicious language threatens to throw out the good with the bad. I am a Chair of Directors / Governors at an excellent Academy and Gove runs the risk (as all “leaders” do) of demoralizing just the people he should be motivating.

In pursuing his political agenda, he shows he is full of ideas but not allied to the skills of a leader. Schools boards / or governing bodies are full of people who (unlike in corporates) are unpaid and fill positions out of a desire to help kids and the staff that run the schools. Gove is at least ten years out of date with his picture of local worthies – it is not just an insult but shows Gove to be stuck in the 1970’s at best.

At schools, the link between Head and Governors / directors can be bad (as it can in any situation) but is often very good. The role of the board as “critical friend” is enshrined in all that is done and the Head (and some of his / her staff) are on the Board as well. This creates a team that motivates each other to work together and develop a school for its students. Where it works (and it usually does to some extent), it provides enthusiasm as well as governance, skills as well as motivation – on both sides, operational and governance.

Of course, Gove has some insights as schools in difficult areas will have trouble finding the skills needed to fill a board. But, this is down to the location and the need to ensure that they are supported within a structure that works. This is a key area and where successful schools can certainly help.

But, Gove should not ridicule the governance structure in schools – it may be the one area that does work!

Third Sector

Now, I work in this sector as a CEO. I have a good Board but having been in the sector for five years or so (my previous 30 were in the corporate one), it is clear that there is a crisis and it is between CEO’s and the Board.

There is a divide that is unnecessary and needs to be fixed. My concern is that it won’t be because the mind-set of third sector participants is that the charity sector is precious and that there needs to be a separation between boards and operations.

The separation is, I am repeatedly told, because of conflicts of interest. These conflicts, if a CEO becomes a Trustee, means, for example, that the roles are somehow confused and that the Chief Exec can no longer properly comment on staff salary issues because of conflicts of interest (see NCVO website).

The Charities Commission is completely confused. Two requests for information on this yielded completely different responses in the last couple of weeks – both suggested a board would need to ensure no conflicts of interest but while one said they would need to approve the appointment and one did not, neither could attest to the specific conflicts that would be in evidence.

What this means is that the separation (which does not happen in Education – and a school is no less precious) is maintained for little reason and the huge benefits – teamwork, joint motivation, openness for example – are lost in the preciousness.

It needs to change and fast.

Governance and Government

Our government shows itself adrift in its response to good governance by the way it shows itself in parliament. Having the Executive commanding the legislature is bad enough but requires a more magisterial quality. Osborne and Balls would not know that if it hit them between the eyes.

It is important that organisations are properly run. They have an enormous impact on society and are a key part of it. It can be argued that civil society has lost its control over organisations as government (our supposed defenders) has clearly shown no tendency to take itself seriously. Osborne and Gove are poor exemplars.

There may be no excuse for the rioters of last summer in England, but the tendency of organisations to show lack of leadership is troublesome and leadership is needed.

The future of Governance

Sectors of society like the three (or maybe four) mentioned above work in silos and come up against each other from time to time. There is much in common and governance issues affect each and all of them.

Governance is the method of governing – it applies to us nationally, internally and within organisations to which most of us belong. Good governance is crucial to the way society works but it is under threat.

The future of society depends on good governance and we now need to unravel the workings of a hundred years of legal doctrine to develop improvements throughout all the sectors of our society.

We need structures that combine strategy and operations, directors / trustees / governors and business / organizational leaders, but where the non-executives are provided with the skills and time to address the concerns that society has.

At the same time, Chief Execs need to be able to explain the key drivers that make (in their view) the organization work and non-execs should be able to investigate for themselves.

Gove wants Ofsted to rigorously assess governors in the way they monitor Heads. Fine (if they had any understanding of what that means and the ability to do it) but who is doing this in corporates – maybe the auditors or some other independent body for any publicly listed company?

Finally, different sectors should not be isolated from each other. NEDs, trustees, governors have a lot in common but all operate to completely separate rules and guidelines. It is time for some common dialogue as civil society (which includes everyone) is getting pretty sick and tired of the mess that organisations are in.