Resisting Corporate Corruption and How to Solve the Compliance Dilemma

Corporate Corruption is a century old problem, but never has their been such a series of scandals in the banking industry as the one we are still experiencing currently and that goes back to the mid-eighties. With the rise of corporations and the fortunes they have built, they also obtained power and influence of unprecedented scale. The scaling back of financial regulation and the subsequent calamities all the way to the Global Financial Crisis of 2007-2008 and beyond has made lawmakers and regulators determined to put an end to it. As a result we have seen a reinforcement of the governing framework and an empowerment of people willing to stand up against corruption. Potential whistleblowers have powerful instruments at their disposal, but the reality is that it still requires a large amount of courage and will to bring corporate wrongdoing to the attention of the authorities.

The third edition of Stephen V. Arbogast’s “Resisting Corporate Corruption” tackles the problem and explores the complex challenges that cause ethical failures and the means available to overcome them with integrity. The book offers twenty-eight case studies and nine essays that cover a full range of business practice, controls and ethics issues. The essays discuss the nature of sound financial controls, root causes of the Financial Crisis, and the evolving nature of whistleblower protections. The cases are framed to instruct students in early identification of ethics problems and how to work such issues within corporate organizations. They also provide would-be whistleblowers with instruction on the challenges they’d face, plus information on the legal protections, and outside supports available should they embark on that course. The cases explore how young employees are often the most vulnerable; they show the ethical dilemmas facing well-known CEOs and the alternatives they can employ to better combine ethical conduct and sound business strategy; and finally, the cases provide an in depth look at how a corporation becomes progressively corrupted, how the Financial Crisis was rooted in ethical decay at institutions across the entire industry, and at the ethical challenges that persist in the post-Crisis, post-Dodd-Frank environment.

Among other things, PlanetCompliance spoke to Prof. Arbogast about the cultural elements of corruption, the impact of technological innovation, and the delicate relationship of the compliance function and the business.

PlanetCompliance: Who is the book for and what do readers get out of it?

Stephen Arbogast:  Firstly, it is for MBA students. My feeling is that business administration programs give short shrift to ethics, financial control and compliance.  Financial control and compliance are either treated as though they don’t exist or as a philosophical exercise as opposed to a challenge to leadership and management. The business schools in the US were shaken by the scandals of the last 20 years.  Ever since the Enron days the questions have increasingly intensified – what are you doing in the ethics area, are you only turning out people motivated by winning any cost?  And so business schools started bringing in ethics curriculum.  Generally, I think these courses are not well-regarded by students.  Generally they feel the courses don’t equip them with a lot of practical understanding of the challenges they are going to face and how they can meet them.  So this book is intended to provide the students with cases that present the real world complexity of ethics, financial control and compliance challenges.  These challenges are presented both through the eyes of the CEO, and through the eyes of the people down in the organisation.  We use this book to put students into the shoes of both CEOs and lower level personnel, and then ask them to identify the ethics issues and work through them to solutions. So MBA students are the primary audience being targeted, but I believe it has similar applications at law schools and for compliance and ethics training inside corporations.
PlanetCompliance: You served as the treasurer of Exxon Chemical and ExxonMobil Chemical Company from 1997-2004. During your career of 32 years at Exxon you were, amongst other assignments, finance manager of Esso Brasileira, treasurer of Exxon Capital Corporation and finance director of Esso Standard Thailand; as treasurer of Chemicals, you were responsible for the financing of Exxon’s $40 billion worldwide chemical business. You also served on joint venture boards with Exxon partners in Saudi Arabia, Australia and the United States. So, truly a global career in a large corporation, which probably puts you into the perfect spot to give your views on the cultural aspect of corruption. Is there a cultural element to corruption in your opinion or is it caused entirely by economic conditions, or are some cultures or societies intrinsically more corrupt than others? 

Stephen Arbogast: It’s a complicated answer to a complex question. It’s difficult to pull apart economic conditions and culture because they interact with each other. I can give you an example from my Exxon days:  after the merger of Exxon and Mobil, Exxon sought to re-establish operations in Nigeria. Later, a  Nigerian CFO  explained that while the income of a  Nigerian employee might be a fraction of the American counterpart,  it was considered a fortune within that employees extended family.  Consequently, the employee was often asked to support as many as 30 to 40 relatives. The employee has a hard time saying no, this is culturally expected.  That puts a lot of pressure directly on local employees and indirectly on a company’s ethics policy.  So there is undoubtedly a cultural aspect but it’s not unconnected from economics.

PlanetCompliance: In the first edition of your book you focused on the Enron case coming to the conclusion that firms get corrupted when the CEO is weak on financial control and allows agency behaviour to corrupt the accounting, compensation and promotion systems. Moving on to the global financial crisis of 2007/2008, could you explain, in broad terms, how an entire industry can become corrupt?

Stephen Arbogast: The book actually makes an attempt to answer this question especially in the essay “Underappreciated Origins of the Financial Crisis.” There I talk about how I saw the banking industry change over my 30+ years at Exxon.  In my view these changes made banking more susceptible to corruption. The short version is that the banking industry that I encountered in the 1970s later ‘commoditised’ and became subject to a very dramatic shakeout.  This is widely unappreciated, but if you go back and look at the names that were on the tombstones for debt or equity issues in the 1970s, most of them are gone, This includes some of the biggest names, ‘bulge bracket’ firms like Solomon Brothers, First Boston and Dillon Read & Co. Those were big names, important firms and they’re all gone. What was happening in the early 1980s, was that traditional banking unravelled rapidly in the face of acute competition posed by, among other things, the invasion of the American banking by European and Japanese universal banks. The banking survivors’ response to this was quite interesting: obviously the US banking industry merged aggressively.  They also attempted to deregulate so that restrictions on banking across state lines fell away.  The biggest change however, was that the all became public companies. Most Wall Street firms had been partnerships with small amounts of capital. By going public, they created large balance sheets which allowed them to build big trading operations. So, we can say that before say 1985 banking was primarily a relationship business, and as a relationship business it had a long-term focus.  Once it becomes dominated by giant trading operations, the relationships are deemphasized.  Trading is much more of a zero-sum game and the emphasis within a trading-dominant bank becomes ‘how do I win consistently at big trading?’  Interestingly, in trading the only way to win consistently is to secure better information than competitors.  Thus, investment banks became more and more interested in harvesting information from their banking franchises and clients.  Banks like Goldman embraced conflict of interest and correspondingly became less interested in serving clients in a disinterested fashion. These are the conditions which set up Wall Street to be a huge conveyor belt for what were known to be very poor, even fraudulent sub-prime mortgage products.

PlanetCompliance: In the aftermath of the financial crisis, a number of other cases have occurred and are still occurring. Despite the best efforts of lawmakers and regulators, is it impossible to create a legal and regulatory framework that avoids cases of corruption of this scale, like for example LIBOR?
Stephen Arbogast:It’s a very good question. I think what happens to an industry when it starts to go bad is that if enough firms participate in the corrupting activity, it becomes very difficult not participate. You get trapped by the competitive dynamics. Lehman Brothers and Bear Stearns made a lot of money trading sub-prime mortgages, so the pressure was on at Citibank and Bank of America to do the same. It takes a lot of restraint and a lot of perspective and leadership from the top to basically say, this stuff is fool’s gold and we are not going to play in it. It is like Chuck Prince, the former Citigroup CEO famously said: “As long as the music is playing you have to get up and dance.” And that was pretty much the attitude.
As far as today’s climate is concerned I would say that the culture on Wall Street is unrepentant.  Right now we are in a situation where regulatory actions have suppressed the instincts to repeat earlier bad practices. I don’t believe there’s really much change in underlying attitudes.  Recently, I was invited to two sessions convened by the New York Federal Reserve Bank that were devoted to promoting an improved financial control culture on Wall Street. The firms mostly sent their Human Resource department personnel, which was basically a way of saying “Ok, we gotta show up but this isn’t really important”.

The post-crisis regulatory effort has been more effective than its critics admit. I think ramping up the capital requirements has been a prudent move and has had a significant effect of restraining the return of ‘big trading.’  Trading is very capital intensive and much of it is unprofitable if you have bigger capital requirements.  So this has been helpful in channelling financial institutions back towards banking clients.  I note with some amusement Goldman Sachs newfound interest in consumer banking.

PlanetCompliance:At the same time we see a lot of pushback from the industry with the argument that regulation has gone too far.  Do you think regulators and lawmakers will be able to resist temptation to scale back or is it simply a question of time until it happens?

Stephen Arbogast: I think this is the fundamental problem:  we adopt a heavy regulatory approach after a crisis.  Then, as long as regulators are active and vigilant, that is when memories are fresh, this restrains bad behaviour.

But just as financial control compliance is a challenge every day, so is regulating the financial industry.  As memories of past crises grow dim, the regulatory agenda can change.  Then, if you don’t have banking cultures that are built around the values of integrity and fairness, the pressures that undermine the regulatory framework are going to come back.  We can see the beginnings of this happening right now.  It’s difficult to say how far and how fast this erosion will happen.  One of the reasons for publishing this book is to help keep the history of these events fresh. Arguably the regulators were asleep in the build-up to the financial crisis and it’s not out of the question that such can happen again.

PlanetCompliance: Does a culture of innovation, i.e. FinTech, decrease the risk of corruption cases, i.e. is the trend towards a start up economy helping with the problem of corporate culture or does the need to make it in a shark tank actually increase the willingness to achieve success at all means?

Stephen Arbogast: I’m probably less expert on this question than other people, but any time you have innovation and disruption in an industry, you have to this regulatory confusion about what’s real and what isn’t. And in that environment it’s difficult to put prices on things and make evaluations, especially for less tangible things like culture. So the technological disruption can open the door to various forms of abuse.  However, it is very interesting to consider whether the potential for abuse is company specific or whether it is systemic.  Where we are right now is – I think that there has been so much regulation and attention on financial scandals that technology’s potential for abuse is more likely to be company specific. I don’t think we will see the kind of behaviour where missteps at a firm like Facebook brings down an entire industry.  That however doesn’t mean we won’t have repeated single firm’s abuse. So to your question whether technology and innovation is a force for stability or corruption, the answer is: both! Technology can do many things, making it easier to compile and analyse data, spot fraud, and monitor compliance.  It also creates disruption and regulatory confusion. But as long as the regulatory environment is robust, you won’t see what we saw in mortgage market of 2005/2006, that is systemic degeneration and predatory practices by an entire industry, completely ignored by the regulators, I don’t think you will see that right now.

PlanetCompliance: In your book you point out that young professionals are especially vulnerable when firms behave unethically. How can they resist pressures to act unethically while protecting themselves and their careers from lasting damage?

Stephen Arbogast: The first thing we advise students is that when going through a recruiting process they should pay some attention to the culture of the firm that they are considering.

Once you’re inside the firm, we suggest that they informally build a network of contacts in audit, controllers, and law.  They should reach out to these people, have lunch with them, understand what they do and what they have to say about the firm. Basically, it’s about building a network of people you can go to later in a challenging situation.

Next we teach students how to build a paper trail if they have concerns about a particular deal on which they are working.  Sometimes superiors who want something done unethically ask not to be included on emails or deal documents.  Those are important warning signs and employees who confront such circumstances need to know how to leave a ‘smart paper trail,’ one that documents where true accountability for the deal resides.

And the last thing we tell them is that if you are in a tough situation; don’t be afraid to get your own lawyer.  This is a vastly underappreciated resource.  If you have your own lawyer, that advocate can take information and go visit people on the board audit or finance committees.  Furthermore, the attorney can do so  without revealing the identity of the employee providing the information.  Finally, the attorney can remind directors of their fiduciary responsibility, of their personal liability for ignoring fraud, and of the attorney’s own obligation to bring the information to the attention of regulators if the Board won’t act.  It’s a very powerful way to get information on fraud in front of the people who can take action, and it also protects the whistleblower.

Today, there are more attorneys who specialize in helping whistleblowers than ever before.  That’s been a positive development since our various scandals and crises.

PlanetCompliance: What would you recommend for compliance professionals with regard to how they should approach a problem in their company and especially create a culture where young professionals come to them and talk to them and it as always very difficult and one doesn’t necessarily trust the other?

Stephen Arbogast: I lived that problem in my Exxon days.  I think it’s very difficult for compliance to do it on its own.  Line managers often just put their fingers up in the air to sense if the senior management really wants compliance to do their job.  My feeling is that there needs to be some sort of financial control champion high up within the firm.  There needs to be someone who sees financial control and compliance as a business asset and an indispensable key to long-term success. There is an essay in the book called “Necessary Ammunition.” It focuses on how strong financial controls and compliance contribute to business success. So, if you’re an auditor or in compliance, you want to find that person in senior management that understands this perspective. And then you go to work with that leader to build a strong culture of financial integrity.

To accomplish this, financial control personnel also have to become knowledgeable about the core business. The feeling among business line managers often is that compliance people don’t understand the business and are not interested in it.  They see the compliance function as just interested in getting the rules followed. And obviously the compliance people feel that the business isn’t interested in compliance.  So this is usually where building a sound culture comes to a screeching halt.  It takes a lot of time and effort to get audit and compliance to think of themselves as consultants for the business and for the business to take responsibility for achieving good financial control.  Those, however have to be the goals.  If senior management understands the role of financial control, it will set itself to the task of building this kind of culture.

Stephen V. Arbogast is the author of  “Resisting Corporate Corruption: Cases in Practical Ethics from Enron through the Financial Crisis“, which is published by Wiley.

He is a Professor of Practice of Finance and Director of the Energy Center at the Kenan-Flagler Business School, University of North Carolina at Chapel Hill. From 2004-2014 he was Executive Professor of Finance at the University of Houston.
From 1972-2004, he worked for ExxonMobil Corporation in various finance positions, serving overseas in Brazil and Thailand, and culminating as Treasurer of ExxonMobil Chemical Company. Since 2010 he has been a member of the Technical Review Panel of the National Renewable Energy Laboratory.

Lavanya Rathnam

Lavanya Rathnam is an experienced technology, finance, and compliance writer. She combines her keen understanding of regulatory frameworks and industry best practices with exemplary writing skills to communicate complex concepts of Governance, Risk, and Compliance (GRC) in clear and accessible language. Lavanya specializes in creating informative and engaging content that educates and empowers readers to make informed decisions. She also works with different companies in the Web 3.0, blockchain, fintech, and EV industries to assess their products’ compliance with evolving regulations and standards.

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