The Australian Securities and Investments Commission's
("ASIC") recent crackdown on corporate culture,
particularly focused on banks, has been fuelling much debate about
the role of boards in the oversight of culture within an
organisation. Some have accused ASIC of attempting to be the
"culture police" and expecting directors to step into the
shoes of management. Others, including ASIC, insist that this is
not the case at all.
In our view, at the core of this debate is a need to clarify the
role of Australian boards in overseeing and monitoring the culture
of an organisation because a poor culture can significantly
increase the risk of poor conduct and ultimately lead to the
destruction of shareholder value, and adversely affect employees,
customers and suppliers.
ASIC Chairman Greg Medcraft has made clear that ASIC will now
incorporate culture into its risk-based surveillance reviews.
Simply put, culture is the values, incentives, policies and
practices that a company adopts.
Why is ASIC so focused on culture? In Mr Medcraft's words:
"Culture matters to ASIC because it is a key driver of
conduct".
"Time and time again, we have seen firms blaming it on a few
bad apples ... rather than taking responsibility by looking more
closely at their organisation and implementing the necessary
changes to address the root cause of the problem".
In light of ASIC's declared crackdown on corporate culture,
Australian boards (particularly those in the financial services
sector) need to ensure their governance systems are effective to
withstand both regulator and potential judicial scrutiny.
This raises the question: To what standard will a court and/or ASIC
hold directors to account when it comes to breaches of law that it
believes flow from a board's failure to engage in proper
oversight of corporate culture? And, what steps can boards take to
mitigate this cultural risk?
Directors of Australian companies are legally exposed in a personal
capacity because they owe a duty of care and diligence, under both
general law and the Corporations Act. This duty requires that
directors take all reasonable steps to place themselves in a
position to guide and monitor the management of the company. In the
2011 Federal Court judgment arising out ASIC's action against
the directors of Centro property group, the court provided some
guidance on the meaning of "all reasonable steps" in the
context of the duty of care and diligence.
"The standard of 'all reasonable steps' is determined
objectively by reference to the particular circumstances of the
case. It requires, at a minimum, that directors take a diligent and
intelligent interest in the information either available to them or
which they might appropriately demand from the executives or other
employees and agents of the company", Justice Middleton
said.
"A director must become familiar with the fundamentals of the
business in which the corporation in engaged. A director is under a
continuing obligation to keep informed about the activities of the
corporation. Directorial management requires a general monitoring
of corporate affairs and policies".
While the Centro case was largely concerned with the duties of
directors in reviewing and approving the company's financial
reports, Australian courts and regulators are likely to apply the
same principles with respect to the duties of directors to oversee
company culture and conduct more generally.
As a starting point, Australian boards need to identify their key
governance and business principles and effectively communicate
these principles to stakeholders. These are the values that will
set the tone for and underpin the company's culture, and which
will be reflected in its strategy, business model, policies,
incentive structures and risk appetite. Some of these principles
will be specific to the type of business and industry involved. For
example, for an airline or mining company, a specific guiding
principle would be a commitment to physical safety. For a bank, it
might be promoting investor trust and confidence and ensuring data
privacy.
In terms of monitoring corporate culture, Australian boards need to
have an effective, probative and independent system to receive
timely and relevant information about the company's affairs in
a systematic, rather than reactive, way.
As part of this process, directors are expected to have an
inquiring mind and put processes in place to manage conflicts of
interest that may arise. At times, this may require the board to
engage external advisers to conduct an independent review.
In circumstances in which it is alleged that a company or one or
more of its employees has engaged in unlawful conduct, courts and
regulators are likely to look at whether the misconduct arises out
of a systemic governance failure within the organisation. This can
expose directors to a risk of being accused of breaching their
directors' duties. In this regard, courts and regulators are
likely to look critically at how boards have objectively tested the
company's adherence to its own governance principles, policies
and practices to deter the risk of that kind of misconduct
occurring in the first place. In particular, ASIC has indicated it
will be looking to see if there is any disconnect between firm
policy and how that policy is actually applied in real time,
including at a board level.
Where the board was on notice of the misconduct, the courts and
ASIC will want to ascertain that the board has taken genuine and
reasonable steps to ensure that firm policy has been followed and
that those responsible (whether directly or indirectly) have been
held accountable for their actions. It is likely that particular
attention will be paid to ensuring that incentive structures and
consequence management policies are consistent with this end.
Going forward, it is likely that further lessons for Australian
boards will emerge as ASIC's current enforcement activities are
played out in courts and elsewhere. However, it is clear that ASIC
is resolved to press on in its crackdown on corporate culture. In
this environment, boards can no longer afford to be complacent
about culture by, in the words of Mr Medcraft, blaming poor
behaviour on "a few bad apples".
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
