Creating a Culture of Compliance

"Tone at the top" is an overused phrase, but if companies want to mitigate fraud senior leaders need to speak up forcefully.

Cell-phone markets in Central America and Southeast Asia were booming early in the decade, and Alcatel SA paid dearly to get in on the action, in more ways than one.

The Paris telecommunications giant doled out $8 million in bribes to “consultants” (including a well-connected perfume distributor in Honduras) to gain access to key government officials awarding lucrative contracts in four countries. When its actions came to light, subsequent prosecution under the Foreign Corrupt Practices Act (FCPA) led to fines estimated to exceed $130 million.

In December, the federal government cited a “lax corporate control environment” at Alcatel, which extended right up to the CEO and CFO, as a primary cause of the scandal. It was a finding that more companies should take to heart.

Nearly a decade after the passage of the Sarbanes-Oxley Act, and amid heightened FCPA enforcement, the responsibility for shaping what is often called a “culture of compliance” inside U.S. corporations falls heavily on the C-suite — and, more than ever, on the CFO.

A culture in which employees feel they can report illegal activities or abuses can prevent problems from becoming disasters. This pertains not only to financial controls under the CFO’s purview but also to a broad range of operational risks, which can result in costly disasters like last year’s oil-rig explosion in the Gulf of Mexico and the implosion of Enron. In both cases, employees accused top management of ignoring their concerns about dangerous internal practices.

Who to warn, and how, remain open questions at most firms, but “if a CFO says, ‘That’s not my department,’ he or she should be fired,” says David Gebler, president of corporate-ethics consultancy Skout Group.

Last December, on the very day that Alcatel-Lucent (the companies merged in 2006, after the events in question were said to have taken place) settled the criminal case, CEO Ben Verwaayen, who joined the company after the violations had occurred, broadcast a message reemphasizing the importance of the company’s zero-tolerance policy for bribery. In an e-mail sent to 78,000 employees deployed in 130 countries, he said that Alcatel-Lucent’s hardware and software sales are “based entirely on the value they bring to our customers. We cannot afford or tolerate any compliance violations, both financially and in terms of our reputation.”

Clear communication from the CEO is a critical first step, but it’s hardly the only step needed. Changing a company’s culture is extremely difficult, and often requires senior executives to untangle delicate in-house politics, agitate profitable operations overseas, and relentlessly police the entire organization’s compliance program. No single e-mail or ethics training course will achieve that.

CFO interviewed more than a dozen experts and examined several notable legal cases and compliance failures to determine the five most effective things finance executives can do to prevent risky or illegal activities.

1) Acknowledge that You Are Responsible

While the actions of a salesperson on the other side of the globe may seem well outside a CFO’s purview, Sarbox says otherwise. When CFOs sign off on financial statements, as they must do under the act, they are also verifying the accuracy of all corporate records, says Marie Hollein, president and CEO of Financial Executives International.

Adding to the pressure, the federal government recently gave whistle-blowers a powerful incentive to snitch. The Dodd-Frank Act awards bonuses of up to 30% of enforcement penalties to individuals who provide “original information” about illegal activity by their employer. Understanding the implications of the new incentives and crafting a policy that encourages employees to speak up is essential.

2) Make the Corporate Counsel Your Ally

As every finance chief knows, there is a crackling tension between compliance and the company’s or business unit’s mandate to perform. CFOs who tackle compliance issues may feel they are entering a political minefield. In such cases, don’t go it alone.

Stephen Pedneault, founder of Forensic Accounting Services, cites a common example: the salesperson who posts big numbers yet puts tens of thousands of dollars in personal expenses on the company credit card. Every month, the CFO approves the expenses, which aren’t tax deductible and should be reported to the Internal Revenue Service on the salesperson’s W-2.

If a CFO questions this, the CEO or the head of the salesperson’s business unit may offer the kind of nonresponse that Pedneault characterizes as, “Thank you for pointing it out; if it gets abusive we’ll take care of it.” That kind of see-no-evil culture has serious ramifications; if employees know such abuse is taking place, it sends a signal that they can abuse the system, too. An employee might say to himself, “If that guy can do it, why can’t I?” says Pedneault.

Thomas Quilty, head of BD Consulting and Investigations, recommends that CFOs establish a strong relationship with the general counsel, who typically has the credibility to make a strong case that a problem is serious and must be addressed. “The corporate counsel wields enormous power within any corporation,” Quilty says. “Any CFO who is not listening to the corporate counsel has got to be crazy.”

3) Really Deliver the Message

“I am sick of the phrase ‘tone at the top,’” says Tracy Coenen, a Chicago investigator. Sending a message from on high is far more effective, she says, when it’s coupled with some face time. Making the effort to deliver this important message in person shows that “you’re a real person, and [your employees] can hear you say that it’s important to have an ethical company.”

The definition of “the top” is also changing. Regulators are demanding that boards of directors assume greater responsibility for shaping a company’s culture. The U.S. Justice Department’s recent bribery case against Panalpina blamed “a culture of corruption,” which “trickled down” from the board and senior executives to “employees who accepted bribery as a part of Panalpina’s standard business practice.”

Employees even adopted a nickname — “apples” — for bribes, according to the November settlement by the global oil-industry logistics firm. Panalpina pleaded guilty to two violations of the FCPA regarding $49 million in cash bribes paid to customs and government officials in Angola, Azerbaijan, Brazil, Nigeria, Russia, and Turkmenistan.

Bill Pollard, a Deloitte Financial Advisory Services partner in Chicago, says companies often make the mistake of putting responsibility for various compliance matters into various separate “silos.” Compliance should be “woven throughout the fabric of the organization,” including the board. Pollard adds that executives responsible for compliance should have “unfettered access to the board.”

At DuPont, employees in 90 countries receive ethics and compliance training, often from the senior-most executive in each country. As a result, the culture is shaped “not just by someone saying this is important, but by demonstrating it,” says Donna Grier, general auditor and chief ethics and compliance officer at DuPont headquarters in Wilmington, Delaware.

DuPont’s message and values are constantly reiterated, she adds. During Chinese New Year, for example, the company highlights employees in China who refuse to accept customers’ traditional offers of cash gifts.

4) Educate Front-Line Managers

While senior executives must set the tone, it is critical that front-line employees feel comfortable in the role of watchdog. When these employees raise potential issues, midlevel bosses and front-line supervisors should know how to respond. Otherwise, employees who know about illegal activities may not tell anyone, out of a fear of being retaliated against or fired. A raft of research has shown that an employee’s behavior is far more influenced by his or her direct supervisor or operating-unit head, versus a C-level executive.

Many companies offer anonymous hotlines as a sort of workaround to that reality, yet only 5% of reports of misconduct come through such hotlines, says Patricia Harned, president of the Ethics Resource Center, a research nonprofit. “If supervisors aren’t supportive” of compliance, she says, “it’s likely employees will keep quiet when problems come up — or leave.”

Consultant Pat Gnazzo has experience with turning a corporate culture around from the inside. He was recruited as chief compliance officer at CA after a $2 billion accounting scandal at the software company in 2004. He says employees who know they are welcome to come forward can prevent systemic failures or scandals. “You may [still] have one person who does something bad in a vacuum. But you will never, ever have [systemic] organizational fraud,” he says.

5) Simulate a Crisis

When a crisis occurs, consultants say that it can be extremely difficult for C-suite executives to subsume their type-A personalities and develop a consensus-driven plan that can minimize further damage. For top managers who want to learn how politics and personalities can lead to a cover-up that worsens a crisis, consultants recommend they walk through who would be in charge if a crisis occurred.

Deloitte’s Pollard sometimes puts executives in a room and asks them to put on a fraudster’s hat: Could someone manipulate company records or processes to perpetrate a fraud, and if so, how? Who in the room has the knowledge and ability to commit fraud?

After one such series of brainstorming sessions, Deloitte catalogued more than 150 initial fraud risks for one public company. “When the CEO and the CFO saw that,” Pollard says, “it opened their eyes to things they had never considered.”

Kimberly Blanton is a freelance writer and a blogger on financial literacy.

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