Three Critical Traits that help Board Members Combat Fraud

July 2017

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Board membership carries with it a sense of corporate status and achievement in one’s professional life. It may raise one’s profile in the corporate world and be rewarded by monetary compensation. It may be seen as an avenue to give back to society and to pursue one’s personal interests, such as a cause they feel passionate about - but are there only positives? Is being a director on a board really as rewarding as it sounds?

There are a number of risks involved when one accepts a board position and agrees to help steer a company in the direction that’s best for its shareholders. One prominent risk is fraud, which impacts companies of all sizes, across all industries. Because a director’s reputation often becomes synonymous with the company’s reputation, it’s vital that board members understand and actively combat the risks posed by fraud. To do so effectively, it’s in the best interest of the director to be:

  • committed to the company’s success
  • aware of any and all threats to that success
  • decisive in his or her actions to prevent potential disaster

Directors are tasked with making tough decisions, asking hard questions, handling unforeseen events and taking bold and decisive actions in the interest of shareholders. In today’s complex business environment, directors need to be up-to-date on industry specific concepts and best practices of corporate governance, while balancing the legal, operational, financial and ethical implications of management’s decisions.

The Successful Director

Unfortunately, it is impossible for an organization’s policies and procedures to prevent a fraudulent actor or group from attempting, or even succeeding in committing every possible type of fraud. If the fraudster can rationalize their behaviour and see an opportunity to commit the fraud with a high chance of success, more often than not, they will do it. No board of directors can do much about the first condition – the fraudster’s motivation and self-justification. However, they can have a significant influence in limiting the opportunity for its success by building safeguards into daily operations of the organization, and providing it with strong and consistent leadership from the top. For that, a specific set of directorial characteristics or traits are necessary.

From experience, we have identified three essential traits for success: commitment, knowledge and decisiveness. While each trait is applicable in different ways, all three are linked and supported by the other two to assist a director in having a meaningful influence on reducing the exposure to fraud in an organization.

1. Commitment

Anecdotally, the most effective directors are those most committed to the goals of the organization. They have a personal motivation to ensure that the organization’s governance is as strong as possible. That means they are prepared to commit the time and effort necessary to understand the different concepts of corporate governance, and to determine where and how these might best be applied in their organization.

Naturally, the committed director will be concerned for the reputation of the organization – its good name is also their own. For example, when it becomes clear that a contract or tender can be acquired only in return for a bribe, the committed director is far more likely to vigorously oppose consenting to such payment. Considering the potential consequences in today’s corporate environment, which include severe legal penalties, the financial cost of litigation, diverted management time, and above all, the potentially ruinous damage to the organization’s reputation, which can now happen instantly via social media, the committed director can help save the organization from disaster.

Moreover, the committed director will be concerned for the makeup of the board itself, specifically the qualities, experience and diversity of its members. In part, this will be motivated by a desire to get the best people into the seats around the table. Yet it will also create a board with a wider breadth of expertise and a deeper resource base of knowledge – qualities that lead to increased performance and increased levels of success when compared to non-diverse groups. And that observation leads to the second essential trait: knowledge.

2. Knowledge

The knowledge requirement for the effective director includes the wherewithal he or she has personally gained about the organization and its governance, and the legal, political and cultural environments in which it operates. Knowledge is power. This is basic. Yet equally important is the willingness to recognize the gaps that may still remain in the board’s collective knowledge, which make it difficult for the director and their peers to evaluate an issue and identify the optimal solution.

For instance, when considering a new relationship with another entity for a joint venture, the board’s financial experts may make a plausible financial case for going ahead. Millions of dollars may ride in the balance. Decisions based solely on the financials may miss the bigger picture. The financials of the partnering company will not reveal its past FCPA violations for bribing officials, or tell you that the president of the potential partner company has been sued by several former partners in the past. A small fraction of the transaction amount can cover the cost of hiring outside experts to thoroughly research the reputational risk associated with the new relationship, or with the venture itself. Negative findings from that research may overturn the entire ratio of costs and benefits related to the proposal and save the organization from a long, drawn-out nightmare. Yet when the proposal has been a popular one with your fellow board members, the effective director who raises a potential red flag will need to put the third essential trait into operation: decisiveness.

3. Decisiveness

Raising challenging questions, pointing out the gaps in a plan, or opposing a measure popular with your fellow directors – these are not comfortable positions to be in. Human nature has a strong tendency to “go along to get along,” yet the effective director recognizes that an uncomfortable position may be necessary for the sake of the organization.

Effective decision making often derives from a high level of skepticism – a kind of “show me” attitude. Trust, but verify when dealing with a potential partner entity or individual. Implement protocols that are consistently followed and thus can be relied upon. When considering a transaction, thorough qualitative and quantitative due diligence can become standard practice. From an operational perspective, implementing a new and tighter system of internal controls can maximize employee compliance and prevent fraudulent activity. There is little point in establishing such a system unless it is strictly monitored on a regular basis and becomes a part of the organizational culture. Initially, employees may grumble about the extra effort required – it wasn’t done before and nothing bad happened, so why do it now? No company ever thinks it will be a victim. The skepticism of a director, and the decisiveness it motivates, can mean the difference between sound, secure management and an opportunity for fraud.

Decisiveness, together with knowledge and commitment, are valuable at every level of an organization – but it is essential to have it at the top. When appropriately applied, the three traits of effective directorship work well together. Commitment and knowledge will tell you what’s right – and decisiveness will enable you to do it.

Awareness: The Best Medicine

In today’s fast-paced business environment, directors need to be keenly aware of potential reputational risks and evolving regulations, and to be vigilant in protecting, if not enhancing, the good name of their organization. These features grow directly through the cultivation of the three traits of the successful director.

We can say from experience that there are few more satisfying professional life experiences than guiding an organization to healthy and growing success, and protecting it from the risks that can threaten its continuity and growth through lack of timely care and good practice. Being cognizant of the risk of fraud and the traits needed at the boardroom table to help mitigate those risks is a good place to start for current and would-be members. There are resources available to help the conscientious director develop his or her skills – courses, workshops and certifications offered by organizations such as the Institute of Corporate Directors. Prospective and serving board members can use these resources to make themselves more effective stewards on behalf of their stakeholders, and better protect themselves from exposure to director liability and other personal risks. More importantly, they will discover the satisfaction of knowing that they inspired and motivated the success of the organizations they govern.

Contributors:

Chetan Sehgal is a Partner and Mike Macdonald is a Senior Manager in BDO’s Forensic and Litigation Support Practice in Toronto, Ontario. Chetan and Mike specialize in the field of investigative and forensic accounting and quantification of damages.

For more information on this or other issues facing your business, please contact your local BDO office.

Chetan Sehgal
Partner – Forensic and Litigation Services
csehgal@bdo.ca

Michael Macdonald
Senior Manager - Forensic and Litigation Services
mmacdonald@bdo.ca