In financial institutions:

Closing the open door to corruption

Keynote address by the Securities and Exchange Commission of Sri Lanka Chairman and the Insurance Board of Sri Lanka Chairman Udayasiri Kariyawasam at the 27th International Symposium on Economic Crime on September 2 at Jesus College, University of Cambridge.

Two recent high-profile financial institution debacles in Sri Lanka, gave a timely reminder of the importance of good corporate governance, and also, the importance of the ethical behaviour of high-ranking officials in private and public sectors.

Even the conduct of internationally renowned auditors was questioned in both these cases, in the sacrosanct areas of ‘due professionals care’ and ‘conflict of interest’.

The Accounting Profession has a leading role to play in preventing corruption. However, if we look at the domain of Management Accounting, where Compliance, Control and Competitive Support are the three main aims, we see a shift in emphasis from Compliance and Control, to Competitive Support, due to market pressures.

It is even suggested that Management Accountants spend less time dealing with financial accounting, audit and tax issues, and spend more time learning about product and process technologies, operation systems, marketing strategy, and behavioural and organizational issues.

While this shift in emphasis helps organizations to survive and grow in the fiercely competitive business world. It diminishes the focus on Compliance and Control, which provide internal safeguards against unethical and corrupt practices.

Consequently, at the Securities and Exchange Commission of Sri Lanka, we strengthened our supervisory, regulatory and surveillance frameworks by implementing a risk-based methodology for all capital market intermediaries, to ensure their financial stability, their operational viability, and their compliance with applicable rules and regulations. We carried out pre-emptive on-site inspections under different risk categories.

We also issued standards on Corporate Governance for mandatory compliance, and developed a Code of Best Practice in association with the Institute of Chartered Accountants of Sri Lanka.

We reviewed the existing legal framework, and identified the need to address issues such as the clarification of definitions of offences, and the introduction of civil sanctions.

If we look at corporate corruption from a broader perspective, we can make some interesting observations. During my training programs over the past two decades, I have presented the conventional interpretation of a SWOT analysis.

Strengths and Weaknesses were considered internal attributes, while opportunities and threats were said to arise from external factors.

However, internal threats arising from corrupt practices, is now forcing us to rethink this model, and examine threats to organisations from internal as well as external sources. In developing countries such as Sri Lanka, we generally associate corruption with public sector enterprises. In the present scenario, this perception needs revision. Many instances of corporate fraud in Sri Lanka and elsewhere have been associated with private-sector enterprises, with public sector officials playing a secondary role.

If high-profile business people and high-ranking Government officials responsible for fraudulent transactions are not sanctioned in any way, they will continue to disregard the distinction between public resources and private wealth, and continue to ignore their economic and social responsibilities.

Such instances, which are far from uncommon in most developing countries, do nothing to discourage corruption and fraud among the elite in the public and private sectors.

Effective antidotes

In practical terms, there are two effective antidotes to corrupt corporate practices.

The first is good corporate governance founded on ethical management practices, which are deeply embedded in an organisation and formally enforced.

The second is Public Interest Litigation, if the detrimental results can be reversed, as in the case of corrupt privatisations of public enterprises.

We have had two such instances in Sri Lanka within the past few months, where the Supreme Court reversed two major privatisation transactions, effected six and seven years ago, as part of the Public Enterprise Reform Program. The Court censured and fined high-ranking individuals including top Government officials.

Good corporate governance is the best way to close the door to corruption.

This requires an enterprise to determine on a range of issues such as directors’ obligation and duties, the structure of the board, the role of auditors and audit committees, disclosure of information, transparency of matters such as executive remuneration and procedures for appointments and promotions. Good corporate governance principles have to meet the aspirations of the organisation, and also its stakeholders who are interested in the long-term stability and integrity of the organisation, and the socio-economic environment in which it operates.

This is the true definition of Corporate Social Responsibility. If we look at the underlying roots of corruption among financial institutions, we often see sequence of events that typically start with poor judgement in the taking of risks, due to corporate or personal greed.

When things go wrong, in an attempt to cover mistakes, recover losses, and save the organisation as well as their jobs, people are tempted take riskier decisions that can easily cross the threshold of corruption. Even though the primary obligation to comply with legal requirements falls on the directors individually, good corporate governance has to permeate the entire management.

Good corporate governance often imposes upon the Board, obligations which go beyond minimal legal requirements.

The management will need to determine to what extent they will use their own benchmarks for voluntary compliance.

Corporate scandals

Despite all provisions in the law relating to good governance and codes of best practices, there is an increasing trend of corporate scandals all over the world. If corporate leaders genuinely want to deliver the expectations of good corporate governance, they need to identify and mitigate threats that could lead to corruption. They need to create a corporate culture that acts as a deterrent against unethical practices at all levels in their organisations. The assumption that employees of an organisation will automatically be motivated to behave as the owners expect, is no longer valid.

People are motivated more by self-interest than in the past, and are likely to come from different cultures that emphasize different personal values. As a result, there is a greater need for clear guidance in identifying and countering threats to good governance and ethical values.

Employees can easily misunderstand the organization’s objectives, and their own role and fiduciary duty, especially in financial institutions that manage other people’s money.

This is why many directors and employees believe that their companies are best served by whatever actions that generated profits in the past.

Employees are often tempted to cut ethical corners, and they do so because:

a) they believe that their top management wants them to do so, or

b) they are ordered to do so, explicitly or implicitly, or

c) they are encouraged to do so by misguided or manipulatable incentive programs.

For example, a commercial bank in Sri Lanka, which had an ‘inflated’ remuneration scheme for its treasury operations staff, discovered a breach of procedure in its dealing room which led to a huge exchange loss. This situation caused the two top officials of the bank to resign, triggered an investigation by the Central Bank, and a probe by the Securities and Exchange Commission into possible insider dealing in share sales prior to the discovery of the Forex loss.

Clearly, the ‘greed factor’ tempted some officers at this bank to cut corners, and take disproportionate risks undue to the exorbitant treasury bonuses they could earn, if things went well. Indeed, in the absence of proper control procedures, if things went well as they expected, their improper actions would have gone undetected, they could have covered the losses, and even won accolades for their outstanding performance in Forex trading!

Lack of proper guidelines or reporting mechanisms in financial institutions may be the result of directors and managers not understanding their fiduciary obligations. Even where good governance practice are in place, compliance mechanisms are often nonexistent, rusty, or neglected, because most directors concentrate on moving the company forward, and not protecting it from ethical downsides. This lack of understanding of fiduciary relations for directors, executives, and also professional accountants, is now widely clarified after the Sarbanes-Oxley act (called SOX). In the US professional accountants at Arthur Andersen forgot they should have been serving the public interest when giving their opinion that Enron’s financial statements were in accordance with generally accepted accounting principles.

The Enron investigation and SOX has clarified the primacy of the public interest as the foremost concern of professional accountants. This clarification is not only for external auditors, but also for professional accountants employed by organisations.

As employees, they owe a loyalty to the employer, but this does not supersede their duty to the public interest, their profession, or themselves.

Failure to identify and manage ethics risk is a major threat to good governance and accountability.

Recognition of the increasing complexity, volatility and risk inherent in modern business operations has led to the requirement for risk identification, assessment and management systems.

The ethics resource centre of the USA has found that there has been little, if any, meaningful reduction in the enterprisewide risk of unethical behaviour, even after many years of high-profile corporate scandals in America. Interestingly, many corporations accept the importance of having a corporate ethics program, even though very little compliance is observed in practice.

To be continued