Fotolia

There have been oversight issues at companies in a variety of industries with a variety of governance structures.

Arthur Kohn is a partner in the New York office of Cleary Gottlieb Steen & Hamilton LLP.  His practice focuses on compensation and benefits matters, including executive compensation, pension compliance and investment, employment law and related matters. He repeatedly has been recognized for his work on behalf of clients by the business and legal press.

Robert Bostrom is Senior Vice President, General Counsel and Corporate Secretary of Abercrombie & Fitch. Bostrom has global oversight and management responsibility for all legal, compliance, ethics and regulatory strategies, services, resources, corporate governance matters and the corporate secretary function. Abercrombie & Fitch Co. is a global specialty retailer of high-quality, casual apparel for Men, Women and kids under the Abercrombie & Fitch, Abercrombie and Hollister Co. brands. The company operates stores in the United States and across Canada, Europe, Asia and the Middle East. The Company also operates e-commerce websites.


 

Christopher P. Skroupa A lot of time was spent talking about the Wells Fargo scandal. What do you think had the largest impact: lack of board involvement in company affairs, management instructions, or employees carrying out the actions? Why?

Arthur Kohn: I think the principal responsibility for the problems that have been identified lies, based on the publicly available information, with management of the banking business unit. It seems to me that there were lapses in terms of what should have been the ordinary course of operation of that business.

I think what was interesting about the conversation at the Skytop Strategies Engagement & Communication conference, which was consistent with other thoughts that I’ve had, is the question of: What more could have been done to enhance the board’s oversight function?

I thought there was some really excellent discussion at the conference about what the responsibility of the board was in these kinds of circumstances, especially given the information and other resources that it would need to alert it to the issues that existed. We talked at the conference about the Wells Fargo situation not being unique, which I think is borne out by facts.

Over the course of the last year or so every crisis situation has had its unique aspects, but, from a broader perspective, there have been oversight issues at companies in a variety of industries with a variety of governance structures. What could be done to mitigate those issues? I came away from the conversation with a view that additional discussion and thought might be warranted concerning the question of what additional resources and information might be usefully provided to the board. I think there is a possibility that changes from current practice might be useful.

Robert Bostrom: I think there were many reasons the Wells Fargo scandal occurred as identified in the Special Report. Clearly, the board was uninformed and not getting adequate information. It also appears as if management and the board may have been ignoring red flags. But that was really after the fact, why did the underlying events occur in the first place? Many of the same 23 causes identified in my study of corporate crises from Enron to Volkswagen are applicable to Wells Fargo.

First, setting unachievable goals with compensation tied to them leads to bad behavior in order to achieve them. A culture of “we will do this” with the unspoken directive of “no matter what.” Coupled with this a strong CEO who did not want to hear about failure or bad news and whose judgment may have been compromised by business rationalization.

Second, decentralized internal control functions lacking true independence and communication and a culture that allowed business to dominate them, impeded independent judgment, assessment and reporting.

Skroupa: Why do communication problems between board and management occur? What can each party do to improve their effort without overstepping their boundaries?

Kohn: I think that’s an excellent question, and in a way that was the central question of the conference. I think the answer, what came out of the conversation, was that there is no “one size fits all.” I know that’s a cliché, but there’s truth to it.

What came out of the conversation at the conference is that from a variety of perspectives and contexts – e.g., of activism, shareholder engagement, virtual shareholder meetings, how the board is organized, its resources and what lines of personal communication exist between the board and management – the parties have to find the right balance, given the risks that they face, to have a productive dynamic in terms of communication between the board and management. Communication sometimes breaks down and that is not easy to fix. You have to work at it, and if you don’t work at it you’re not going get it right.

I think a deeper answer is that in some ways the board and management can kind of stake out an arm’s length relationship with each other, as they play their own roles in the dynamic. Shareholders also play a role in the governance framework. All three parties can, and should, stake out arm’s length relationships with each other. The board, for example, has to be independent of management, and shareholders have to play their own distinct role. But if you don’t have the right balance and you take the arm’s length position too far, you won’t get the kind of information and coordination and dialogue that’s necessary to avoid the situations like the scandals that we’ve seen. And so the three parties have to view themselves as partners in a way. They don’t have identical interests, but they don’t have adversarial interests and they should view themselves in a way so they might be more like partners to make sure the crises don’t occur.

Bostrom: For many reasons and they can be intentional or unintentional. There are the traditional governance concepts of oversight and management, but there is really so much more.

In many of the corporate crises that I have studied, management clearly was intentionally misleading the Board and/providing the Board with inadequate information. One of the most important roles of the Board is to ask the right questions and get the answers. Be aware of red flags and act on them. Trust but verify.

More generally, communications problems occur when there are divergent views of the roles and responsibilities of management and the Board, especially when management feels that the Board has overstepped its oversight role and is micro-managing.

However, there are times and circumstances when the Board may have to go beyond the more limited role of oversight, e.g., corporate crises, inexperienced management team, Imperial CEO, business transformation, restructuring and poor financial performance. Under these circumstances, the roles and responsibilities must be clearly articulated to avoid dysfunction.

Skroupa: What is the role of the Board in risk management?

Bostrom: The Board should have an effective governance structure to establish risk tolerance levels for the company and to oversee and assess management’s enterprise wide risk management process and appropriate risk reporting to the Board by independent functions – chief risk officer or legal.

The Board must also ensure that it is fully and timely apprised of risks faced by the company and that management has implemented and maintained effective risk management system and culture including policies and procedures, training and a governance structure.

Kohn: The Board has an oversight role. It needs to be aware of and understand business risks to an extent that is sufficient for it to provide guidance in mitigating, addressing and remediating the risks that exist. While the Board is not responsible for managing the business, its oversight responsibility requires that the Board have a sufficient grasp of the business risks that it can make informed business judgments in its oversight capacity.


Originally published on Forbes.com. More articles by Christopher Skroupa on his Forbes column.