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The role of regulators in effecting cultural change

While some business leaders may feel that regulators have no role in defining company culture, there is growing appreciation that individual and corporate misconduct rarely occurs in a vacuum, according to Andrew Pavlovic, partner at CM Murray

There have been numerous recent examples of company collapses and failings which have been attributed to unhealthy corporate cultures. As a result, cultivating the right culture is increasingly being seen less as an aspirational goal and more of a critical factor in a company’s success.

In a 2016 report, the Financial Reporting Council (FRC) defined corporate culture as a “combination of the values, attitudes and behaviours manifested by a company in its operations and relations with its stakeholders”. The FRC’s UK Corporate Governance Code (2018) provides that boards are responsible for assessing and monitoring corporate culture.

Despite the introduction of a positive obligation on companies to monitor culture in the 2018 code, the FRC was criticised in some quarters for failing to provide sufficient support and guidance to company boards as to what a good corporate culture looks like. In December 2021, the FRC sought to address this criticism by publishing a detailed review highlighting a number of factors which are critical in effecting cultural change, including the following:

  • Leadership – CEOs and boards play a vital role in both embedding a firm’s culture and driving it forward, communicating the right messages to managers and empowering them to enact changes. CEOs and senior management should be visible in an organisation and set the tone in their communications with staff;
  • Speak-up Culture’ – Companies should aim to cultivate a culture in which employees can speak freely, be that in relation to mental health matters, admitting mistakes or challenging board strategic decision-making; and
  • Internal audits – Companies need to develop appropriate tools to assess their employees’ understanding of the firm’s culture. Whilst staff surveys can play an important role, they are, on their own, unlikely to be sufficient, with direct engagement from boards through site visits identified as an important way in establishing that a firm’s culture is understood throughout each level of the organisation.

How can corporate culture be regulated?

As the focus on corporate culture intensifies, regulators are increasingly likely to look carefully at cases of individual misconduct to establish whether that misconduct has a systemic or cultural cause.

The Solicitors Regulation Authority, the body that regulates solicitors in England and Wales, has recently published guidance on workplace environments in which it makes clear that, in appropriate cases, it will pursue cases against law firms for breaches of the Solicitors Code of Conduct for Firms, where it appears that the firm’s failure to cultivate the correct culture has resulted in or contributed to individual misconduct.

The recent Tribunal hearing to determine the FRC’s allegations against KPMG and six of its auditors regarding the Carillion and Regenersis audits raises interesting issues from a cultural perspective.

In both instances the FRC allege that KPMG’s auditors acted dishonestly and/or with a lack of integrity in creating backdated documents/minutes etc., which gave the FRC the impression that more work had been done on the audits than was the case.

The six auditors are of varying experience, ranging from senior partners to more junior members of the profession, the youngest of whom was 25 years old at the time of the audits. Various defences have been deployed by the auditors, with the senior partner alleging he had no involvement in or knowledge of the creation of the relevant documents, and the junior auditors alleging that they created the relevant documents upon the instruction of more senior individuals, acting without any dishonest intent.

Whilst the Tribunal’s judgment is awaited, KPMG have already conceded in a media statement that misconduct had occurred, and the regulator had been misled, whilst emphasising that the conduct had been self-reported by them and that such conduct was not systemic or representative of the firm’s conduct more generally.

However, whilst on an admittedly small scale, the case would seem to engage cultural issues, with senior individuals failing to demonstrate the required standards of integrity and junior individuals failing to “speak-up” and challenge the instructions given.  These cultural issues are likely to be of increasing importance to regulators going forward.

Cultivating the right culture

There are numerous reasons why companies should be invested in cultivating the right culture in their organisation. A supportive environment leads to a happier workforce, higher rates of retention, and reduced staff absences due to stress and/or sickness, among other things. Both investors and prospective employees are increasingly looking at a company’s corporate culture when deciding whether to invest in or join an organisation.

In that context, the increased scrutiny of corporate culture by regulators should not be dismissed as an inconvenience and, instead, should be seen as reinforcing the need for companies to prioritise cultural change.

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