Tony Featherstone discusses how regulatory moves on corporate culture in financial services need careful consideration.

    Company directors are deeply concerned by the corporate regulator’s proposal to introduce personal and corporate liability for organisation culture. If introduced, the changes would effectively regulate corporate culture and increase director risk.

    A war of words on the issue erupted in March as prominent former bankers savaged the Australian Securities and Investments Commission for a seemingly prescriptive approach to culture. ASIC hit back, saying it had no intention to regulate culture by ‘black-letter law’.

    ASIC last year controversially recommended amendments to the Corporations Act 2001 and the Australian Securities and Investments Commission Act 2001.

    The laws would extend Part 2.5 of the Criminal Code Act 1995 to provisions of the Corporations Act that regulate financial services and markets. That could expose a corporation, and its directors and officers, to criminal liability.

    The laws would also introduce new offences that impose civil penalties and administrative sanctions on directors and officers as accessories to contraventions of the law. Directors could be charged if the corporate culture encouraged, tolerated or led to non-compliance, or if the organisation failed to maintain a corporate culture that complied with relevant provisions.

    ASIC has said it will incorporate culture into its risk-surveillance reviews and enforce the law if an organisation’s poor corporate culture is shown to drive bad outcomes. It will also communicate with firms where it has an issue with culture, in turn alerting boards to culture problems they might not realise exist within the organisation.

    Consequently, directors who govern organisations with a corporate culture that encourages law-breaking, and do not take steps to ensure problems are being addressed, could face significant personal liability.

    Risks of a prescriptive approach to culture

    Governance experts believe ASIC is overstepping its mark. John Colvin, the former CEO and managing director of the Australian Institute of Company Directors (AICD), and James Argent, a law graduate at Herbert Smith Freehills, argue ASIC should not use corporate culture to impose liability on corporations, directors and officers.

    In their important paper, Corporate and Personal Liability for ‘Culture’ in Corporations?”, the authors said “culture cannot be effectively defined” or “precisely measured”, that “culture is a concept that should not be regulated” and that the “proposed laws could significantly expand ASIC’s powers and such powers may be open to abuse”.

    Colvin and Argent wrote: “Even if culture could be regulated, more regulation is not the answer. ASIC’s proposal would have a detrimental effect on, and add to the regulatory burden faced by, corporations, directors and officers.”

    In evidence to the Senate Standing Committee on Economics in June 2015, ASIC argued culture is a major risk to investor trust and confidence, and the orderly operation of financial markets – a view not lost on investors, who believe the 2008-09 GFC was a result of corporate culture in investment banks that encouraged reckless behaviour, or those concerned about recent scandals in Australian banks.

    Professor Paul Kerin, Head of the School of Economics at the University of Adelaide, and a noted strategy expert, is surprised by ASIC’s move. “Who are regulators to decide if an organisation has an appropriate culture?” he says. “Academics cannot even agree on how to measure corporate culture; trying to regulate it makes no sense and it would be hard to prove that a director is liable if their organisation’s culture is inappropriate.”

    Professor Kerin says directors should be accountable if bad behaviours are endemic in their organisation. “But penalising bad behaviours of individuals is very different to penalising companies for inappropriate culture. An organisation that has a good culture might still experience bad behaviours from time to time.”

    Amendments would add to regulation/compliance burden on boards

    Concerns that organisations face an ever-rising amount of regulation and compliance are inflaming the governance community’s criticism of ASIC’s proposals. The majority of directors surveyed for the AICD Director Sentiment Index believe governance regulations are onerous and they expect more red-tape.

    Anecdotally, boards want to spend greater time on strategy and governance for performance, and less on compliance-related box-ticking.

    However, ASIC’s move on corporate culture, if passed into law, could lead to organisations hiring a chief culture officer and boards forming culture committees or taking other steps to define, measure and monitor culture. It could also encourage boards to become more risk-averse if they have to rein in an organisation’s entrepreneurial culture out of fear of being prosecuted for isolated bad behaviours.

    Philip Armstrong, director of governance at Gavi in Switzerland, has predicted “governance will move to a much more regulated environment over the next decade”. Commenting in the February 2016 issue of Company Director Journal, Armstrong said: “The big challenge for boards over 10 to 15 years is that governance will be seen as a parallel form of regulation.”

    Armstrong’s prediction might arrive earlier than expected in Australia if corporate culture is regulated. But other experts believe greater focus on culture is an opportunity for boards.

    An alternate view

    Dr Simon Longstaff, AO, Executive Director of The Ethics Centre, says the governance community is over-reacting to ASIC’s proposed amendments. “I do not understand why this proposal has caused so much fuss,” he says. “ASIC is not attempting to regulate corporate culture; rather, it is saying that if boards are recklessly indifferent to the quality and character of corporate culture in the companies they govern, or if they encourage or support a culture of indifference to appropriate standards of law, then they should be held accountable, even if they have ticked all the compliance boxes along the way.” Dr Longstaff is part of ASIC’s External Advisory Panel.

    He says that boards should be aware that the status of an organisation's culture already has formal status in Australian law. “The culture provisions in the Criminal Code Act (Part 2.5) have applied to corporations for more than 20 years. Their existence hasn’t brought about the 'end of the corporate world' and directors have been silent about these provisions for decades. Extending those provisions to the Corporations Act is a sensible approach by ASIC - especially when company directors so freely acknowledge the central role that culture plays in good governance."

    Criticisms that organisation culture cannot be defined or measured are naive, Dr Longstaff says. “Culture has been defined for a long time - including in Australian law - and our work in this area [through The Ethics Centre's Everest Program on corporate culture] shows it can be measured with a high degree of accuracy - and with beneficial practical effects. The tools are there for use by directors if only they want to take them up.”

    The amendments, he says, are about ensuring boards make a consistent effort to understand culture and ensure problems are being addressed. “When you wrap it all together, ASIC is not telling organisations which culture they should have. It is saying, ‘we simply want to know the organisation has a clear understanding of what its culture ought to be; that it is measuring the extent to which that is true; and that it is managing gaps in culture that go beyond ticking compliance boxes at board and management level’.”

    Dr Longstaff says the proposed amendments are an opportunity for boards. “I would have thought the changes strengthen the defence of organisations that have sound corporate cultures and where boards take their responsibility in this area seriously … they will have a stronger footing for a defence against any prosecution.”

    Greater focus on organisational culture will, over time, change some board and management processes, he says. “Companies will move away from the standard employee engagement surveys, which can be (and often are) 'gamed' and do not work, and start to understand their culture more deeply. Boards, I hope, will think more about culture and its ethical foundations - with this reflected in areas such as board papers and meetings – and even influencing significant practical decisions such as capital allocation. As things stand today, I doubt too many boards think about how a large investment will affect the organisation’s culture.”

    Like others interviewed for this feature, Dr Longstaff believes directors should not be personally liable for breaches in corporate culture, provided that they have acted in good faith. “If directors have been consciously driving a culture that encourages the law to be breached, or have been recklessly indifferent, then it is right for the law to hold them accountable. But directors who sought to address cultural problems should receive proper recognition and not be held personally liable if there are isolated incidents of rogue conduct.”

    He adds: “There is an opportunity for a conversation between ASIC and the governance community to find an appropriate balance on director liability around corporate culture.”

    Organisation culture the wrong tool to protect consumers

    Steven Cole, FAICD, says both sides of the debate are technically correct, but that ASIC’s language implies it is an offence if companies have a poor culture. “It’s like a scene from the movie Minority Report, where you have thought police trying to predict if you will do something wrong. A company with a bad culture has not done anything wrong, provided it did not offend the law.”

    Cole chairs Neometals and Reed Industrial Minerals, and is a director of Matrix Composites & Engineering. He has had a prominent career in law over four decades and follows legal developments that relate to governance.

    Cole says no sensible board would dispute the importance of corporate culture to good governance and sustainable organisation performance. “I don’t have a problem with directors who turn a blind eye to criminal behaviour, being penalised. But culture is not something that should be defensively policed through sanctions or penalties.”

    The core problem, Cole says, is ASIC’s attempt to use corporate culture to protect consumers. “The proposed amendments are driven out of longstanding structural problems in the financial services sector; namely, that ASIC believes financial service organisations should act in the best interests of customers, when the duty of a bank, for example, is to act in the best interests of its shareholders. The law requires corporations not to mislead or deceive customers, but there is no fiduciary duty to act in their best interests.”

    Cole adds: “The regulator cannot use corporate culture to fix this grey area of organisation responsibility. ASIC is overcooking its power with culture and becoming far too prescriptive. It’s also a bit of a Johnny-come-lately: boards have done significant work in helping improve corporate culture. It seems a heavy-handed, unnecessary approach.”

    Tony Featherstone is Consulting Editor of the AICD Governance Leadership Centre and a former Managing Editor of BRW magazine.

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