There is a danger in losing sight of what is important and what works

ASIC’s agitation with conflicts of interest arising from the vertically integrated businesses in the financial services sector has contributed to a debate on the extent that company “culture” should be regulated, and board directors held to account.

The recent ASIC agitation is consistent with Guerdon Associates’ review of ASIC’s 4 year corporate plan (see HERE).

This heavy focus has a lot of people in a lather:

• ASIC, which has observed first hand consumer abuse from conflicts of interest.

• Lawyers, savouring work arising from criminalisation of culture at board level.

• Directors, who understandably do not want to be criminally liable for oversight of a woolly concept, and who believe there needs to be some management freedom to develop cultures that assist them achieve business strategies.

• Consumers, wary of being ripped off, and mistrustful of big corporations.

• Politicians, keen to make political capital

This article considers what culture is, and questions if this is the right concept for regulation.

Criminalising corporate culture transgressions

ASIC is pushing for increased powers to target poor culture.

Section 12.3 of the Commonwealth Criminal Code provides that a company may be found to have committed an offence under certain provisions of the Code if it is proved that a corporate culture existed within the company that ‘directed, encouraged, tolerated or led to non-compliance with the relevant provision’ or which did not require compliance with the provision (see HERE).

ASIC has called for this section to be extended to the financial services and financial product provisions of the Corporations Act, and to extend liability to not only the company, but also responsible directors and management, as accessories to the breach.

There is a question as to whether criminalising cultural failures will achieve the ends ASIC requires (i.e. more compliant behaviour). For example, Guerdon Associates undertook research for a board in the Energy sector interested in ensuring appropriate management incentives were in place for improving safety outcomes. This considered what was possible by benchmarking performance relative to other companies, rather than just improving on prior performance. Our findings surprised us. Despite an Australian board director being criminally liable for poor safety outcomes, Australian energy companies’ safety performance lagged far behind the best foreign energy companies where their board directors were not criminally liable. That is, making directors criminally liable does not, on this evidence, lead to the results desired.

ASIC sets the tone with seven key indicators of culture

ASIC’s work on culture has led to the development of what it considers to be seven key indicators of culture (see HERE). These are set out in Table 1.

Table 1: ASIC’s Indicators of culture

#	Indicator	Explanation
1	Tone	‘Tone from the top’: what is the attitude of the CEO, board and senior management? For example, what drives business decisions and what is the attitude to risk management?
2	Spread	Does this ‘tone’ cascade down to the rest of the organisation?
3	Business practices	How is the tone translated into business practices?
4	Accountability	Is there accountability?
5	Communication and challenge	Is there open communication and effective challenge of the business practices, procedures and messaging?
6	Recruitment, training and remuneration	Is the conflicts management policy supported by recruitment, training and remuneration?
7	Governance	What is the governance framework?

 

It seems, then, that ASIC’s work on culture rides a lot on identifying a “tone”. We are not aware of too many board directors who would agree that this is helpful.

What is culture?

So, what is culture? If we define it, then we can see if it can be regulated.

A popular definition defines culture as “a system of shared assumptions, values, and beliefs, which governs how people behave in organizations”. This definition reflects common misconceptions held by most people, including politicians who make the laws, regulators who enforce them, and even many company directors (see, for example, comments by Dr Ken Henry that the regulatory interest in culture was “understandable” because “culture drives conduct” HERE). That is, that attitudes, beliefs and values govern behaviour.

This is not valid. More than 60 years of behavioural research clearly shows that behaviour is not governed by attitudes, beliefs and values but, rather, it is the other way around. Attitudes, values and beliefs stem from behaviour.

Practically, this means that the best a board should be expected to do is ensure that systemic incentives and reinforcers of behaviour are consistent, meaningful, effective and appropriate. For example, an employee who believes her clients should receive unbiased financial advice, but who receives a commission on the volume of company financial products sold, will experience cognitive dissonance until one of two things happen:

• she sells company financial products, takes the commission, and changes her values and beliefs to justify her new behaviour, or

• she leaves the job to do something else, whereby there is a match between her behaviour and the organisation system she is a part of.

During her period of dissonance she may blow the whistle. But she is only likely to do this if the behaviour she observes is inconsistent with company policies, systems and processes. If she observes that the system supports the behaviour through recruitment, pay increases, incentives, appraisals and promotions, she will resolve the dissonance by justifying changes in values, beliefs and attitudes consistent with her behaviour, or seek employment elsewhere (even if this is in another part of the bank with different reward systems). Either way, the people doing the job in the company will, over time, reflect the values implicit in the behaviours they are being economically rewarded for.

So it follows, why bother assessing beliefs, attitudes and values when behaviour can be observed and verified? Why penalise a woolly concept like “attitudes”, when these are only outcomes of behaviour? Why spend vast sums trying to prove an attitude exists when it would be far less expensive to verify behaviour?

Section 12.3 of the Commonwealth Criminal Code defines “corporate culture” as an attitude, policy, rule, course of conduct or practice existing within the body corporate generally or in the part of the body corporate in which the relevant activities takes place. This is a more practical definition, as all but “attitude” can reasonably be validated.

Even with behaviour there are limits to regulation

However, even with behaviour, as opposed to “culture”, there are limits to regulation if Australia is to encourage innovation and, yes, appropriate risk-taking. There is some hope that civil servants, other than our ASIC Commissioners, agree. A recent speech by John Fraser, Secretary to the Treasury, put it quite succinctly:

“And behaviours, in general, are not directly amenable to legislation or regulation.

Indeed, attempting to regulate individual behaviours can be very counterproductive.

It can create a narrow compliance culture, effectively absolving institutions of their ethical responsibilities – the “if something isn’t explicitly forbidden, then it must be alright” mindset.

The focus becomes “how do we find ways to get around the rules”, rather than on doing what is right and sustainable over time.

While specific rule-making has limits, active supervision and discussion has been shown to be an important catalyst for positive cultural change.”

See Mr Fraser’s speech HERE.

His perspective is supported by APRA. In a recent speech, Wayne Byers, chairman of APRA, said:

“Finally, it would seem no regulatory speech these days is complete without a few words on the issue of culture. Regulators have variously been accused of being on a culture crusade, and wanting to be the culture police. That’s not the case: indeed, regulators are really keen to see the industry lead the running on this issue. We need the financial sector to take up the challenge to put in place better incentives for prudent behaviour, so as to prevent problems emerging in the first place. That is likely to be far more productive than spending our time removing so-called ‘bad apples’ after the fact.”

In effect, APRA want to see systemic, consistent and appropriate incentives for prudent behaviour. While they, and others, talk of culture, it is appropriate behaviour that all would acknowledge as most important.

See Mr Byers’ speech HERE.

Conclusions

Our research leads us to a few obvious conclusions:

• There is no evidence, to our knowledge, that making directors criminally liable for undesirable company outcomes will improve these outcomes.
• According to the definitions, regulating culture means ascertaining “attitudes and/or values and/or beliefs”. This is clearly an ambitious (if not impossible) requirement to place on boards, much less the regulator in trying to prove an inappropriate culture. But, more importantly, who in the world would want their boss, the police, or the courts trying to get inside their head to ascertain attitudes, values and beliefs? We are not sure ASIC, nor anyone else, really means that it would be a positive thing to achieve an Orwellian “1984”-like society.
• It is much easier for boards and regulators to oversight behaviour and economic systems that reward this behaviour. It is behaviour that reflects values and beliefs. It is behaviour that causes harm. It is observable. It is verifiable. It is enforceable.
• ASIC already has powers to discipline behaviour. Disciplining behaviour, rather than “culture”, should be the emphasis.
• While boards are rushing to head off more regulation by demonstrating action on “culture”, they are best served by ditching the employee culture and engagement surveys for thorough reviews of the whistleblowing, recruitment, termination, appraisal, promotion, job grading, recognition, pay increase, performance measure, incentive pay, clawback and malus systems to ensure they consistently guerdon appropriate behaviour.

 

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