It’s not always just unscrupulous organizations that find themselves in the midst of a corporate scandal, but every corporate scandal ultimately has knock-on impacts for entity management.
Whether it’s financial irregularities, failure to fulfill director responsibilities, or deliberate circumventing of ethics or regulations, corporate scandals can impact not just the entity in question but the wider subsidiary structure, too, bringing more intense scrutiny over the organization’s compliance and governance practices, and often resulting in stricter regulation for all entities to adhere to – which means more resources need to be dedicated to in-house ethics, governance and compliance.
Every jurisdiction has its own nuances when it comes to the responsibilities of directors and officers in a business entity, but the underlying principle remains the same: The directors can be held responsible for anything that goes wrong in the entity for which they are a director. There are codes and standards of conduct to which directors must adhere, or face serious consequences such as fines, sanctions and even jail time.
The personal responsibility taken on by directors is increasingly emphasized as regulators demand more transparency of organizations, and more coordinated thinking across jurisdictions. An entity’s directors must all sign up to behavior codes and pay strict attention to all that’s expected of them; if they don’t, they could bring down not just their personal reputation, but the entire company’s.
Failure of corporate duties brings corporate scandals
It’s not just directors, of course – scandals can be brought on at any level of an organization, for any reason and for any failure.
Corporate scandals in accounting practices
Take Enron, for example. The source of one of the most famous corporate scandals of all time, the issues began in early 2001, when analysts raised questions about the accounts presented in the company’s previous annual report. The accounts used irregular procedures, making it difficult to work out how the company was turning a profit. The Securities and Exchange Commission (SEC) investigated and discovered Enron was hiding billions of dollars in liabilities through special purpose entities, enabling the company to appear profitable even though it was hemorrhaging cash. In this case, it was a failure of accounting duties and unethical practices that brought about the corporate scandal, leading to more regulatory scrutiny of accounting practices and a need to have clear, auditable accounts as part of entity management practices. It also directly led to the Sarbanes-Oxley Act, which has had a profound impact on the boardroom and on the capital markets.
Corporate scandals in borrowing practices
Then there was the time Lehman Brothers took down the entire global financial markets. Lehman Brothers filed for bankruptcy in 2008, after borrowing significant capital for many years to provide subprime loans. It got to a situation where Lehman Brothers’ outstanding loans exceeded its capital many times over, and so the company used repurchase agreements to disguise “at risk” assets – that is, it sold its liabilities to banks in the Cayman Islands with a promise to repurchase them at a later date. As the subprime mortgage crisis took effect, Lehman Brothers’ clients were defaulting on their loans, and more than 70% of its value was wiped out in the first half of 2008 alone. The downfall of Lehman Brothers led to more scrutiny over bank lending and borrowing practices, and a swathe of now-global regulations regarding transparency and ownership to which entity managers must pay careful attention.
Corporate scandals in sustainability responsibilities
Environmental regulators are also putting increasing pressure on entities to maintain a certain level of sustainable practices and failure to be mindful of the environment can lead to great corporate scandals. There have been two in the last decade to mention here. First, there was the Volkswagen emissions scandal, in which the US Environmental Protection Agency (EPA) announced it believed VW had cheated on its emissions tests. The company had been fitting a device to diesel cars that included software to detect when the car was undergoing laboratory testing and turn on controls to reduce nitrogen emissions; in some cases, the cars were actually emitting up to 40 times the nitrogen dioxide limit when driving on the road. And, of course, we couldn’t mention environmental corporate scandals of recent years without bringing up Deepwater Horizon, BP’s 2010 disaster where an explosion at an oil rig resulted in 4.9 million barrels of oil spilling into the ocean, devastating the local ecosystem and causing a dramatic fall in BP’s share price.
One of these corporate scandals was an accident, the other deliberate, but both saw entities run afoul of strict environmental regulations, ultimately causing huge reputational damage. The result for entity management was tighter scrutiny and a need for much more attention to be paid to environmental regulation at both companies – these disasters are both hovering like a shadow over each group, threatening to wreak more havoc if there’s another slip-up in environmental compliance.
Corporate scandals arising from breaches in ethics
The fall of former Nissan chairman Carlos Ghosn not only sent shockwaves through the global automobile industry, but also led to Japan’s current review and tightening of corporate governance practices. Nissan claims Ghosn had been systematically under-reporting his earnings to security regulators and misusing company assets for personal benefit, and he was arrested on suspicion of financial misconduct in October 2018, in turn throwing into doubt the future of The Alliance, a global car-making group that includes Renault, Nissan and Mitsubishi. Ghosn’s fall has also brought Japan’s corporate governance practices into sharp focus, with trickle-down effects to every entity in that country.
But that is a breach in ethics from one person; what happens if an entire company is seen as breaching ethics? That could be the case with both Apple and Facebook. The former was forced to admit that it was trying to force users to upgrade their phones by deliberately slowing devices as they aged; the latter has been mired in questions about ethical use of data for several years – you can take the Cambridge Analytica case as an example, but Facebook has faced more than its fair share of corporate scandals in recent years. In both cases, it could be argued that the scandal impacted share price and consumer confidence, ultimately leading to a need for more robust compliance and governance processes, though a question mark continues to hang over Facebook’s governance practices.
Cybersecurity-based corporate scandals
A very modern part of entity management falls to the world of cybersecurity. Without top-rated security governance practices, an entity or group faces the risk of confidential corporate or customer information leaking into the public domain. There’s been no shortage of data leaks leading to corporate scandals for companies large and small in recent years, but perhaps the biggest of them all was Equifax’s 2017 security breach, which had the potential to affect around 145 million US consumers, plus many more around the world. Data stolen included names, social security numbers, birth dates and addresses – that is, the type of information typically used to confirm identities. In this case, the corporate scandal’s impact on entity management exposed failings in cybersecurity practices that had to be urgently addressed, while the company also had to rebuild consumer trust in its service.
Flexibility and robust processes are key in entity management
Even if a corporate scandal is restricted to one entity only, or one rogue trader (as was the case with Barings Bank, brought down by Nick Leeson more than 20 years ago), it can still impact the entire subsidiary structure. No entity management process is failsafe, which is why it’s important for organizations to have robust compliance and governance practices that retain the flexibility to move and react to emerging information. If a corporate scandal hits, the entity management, compliance and governance processes must be able to switch gears to deal with the scandal while reassuring stakeholders and customers that the issue has been dealt with and won’t happen again.
Failure to deal effectively with corporate scandals can result in increased scrutiny both from regulators and stakeholders; it can negatively impact the value of the company and it can easily spell the end of the line, as Lehman Brothers and Enron both discovered.
To keep a close eye on all aspects of compliance and governance, it pays dividends to invest in entity management software. This technology not only provides a safe and secure central repository for all entity documentation, but it also allows reporting on governance and compliance requirements, highlighting any areas of concern and allowing the General Counsel to run a tight, compliant ship.
Diligent Entities is one such software, and it also integrates seamlessly with a board portal and secure file-sharing platform to create the Governance Cloud, an end-to-end technology solution to help mitigate the risk of corporate scandals and gain visibility into all aspects of entity management and governance.
Get in touch and schedule a demo to see how Diligent Entities can help you to mitigate the risk of corporate scandals and their impact on entity management.