After the Fall

15 September 2017 - Prof Deon Rossouw

How to deal with ethical failure in organisations

Moral infallibility is a myth. As individuals, we all make ethical judgement errors and act unethically at times. If this is true of individuals, it is even more true of organisations. Organisations are complex systems, and we should therefore not be surprised when organisations commit ethical failures.

Although both individuals and organisations are likely to be involved in ethical failures from time to time, this should not lead us to conclude that ethical failures are excusable. They are not. They might be understandable in some cases, but they are not excusable.

The current outrage about ethical failures in organisations such as Bell Pottinger, KPMG, Eskom, McKinsey, Prasa and many others implicated in state capture, is understandable. What happened in these organisations is inexcusable, and we cannot turn a blind eye to these failures and move on as if nothing seriously wrong has happened. Were we to do so, our collective sense of justice would be damaged, and a dangerous precedent would be set.

So, how should we judge these ethical failures? And how can the affected organisations recover from these ethical failures?

‘Failure to prevent ethical failure is an ethical failure’

All organisations should be aware that they constantly face the risk of ethical failure. And they should be equally aware that ethical failures cannot only cause severe reputational harm, but can lead to demise. We witnessed this with Arthur Anderson, the auditors of Enron, and we see it now again with Bell Pottinger, which has been put into administration as a consequence of serious ethical failure.

It is thus imperative that organisations should not wait for an ethical failure to occur before taking action. To the contrary, organisations should do everything in their power to proactively prevent ethical failures. Failure to prevent ethical failure is, in itself, an ethical failure.

In auditing firms, for example, the independence of auditors is a major potential ethical risk. If auditors do not maintain their independence, they put their own firm’s reputation at risk, as well as the reputation of the auditing profession as a whole. Auditing firms are therefore expected to guard against cosy client relationships that jeopardise their independence.

Currently, KPMG is being accused of exactly this ethical failure. The fact that four Partners attended the wedding of relatives of one of their audit clients, is widely regarded as a serious breach of independence. What makes this breach even more reprehensible is that the executive level did nothing to prevent their staff from attending the wedding, but in fact approved of it. This surely implies a deeply compromised internal process, and the firm has since admitted that allowing their staff to attend was an ethical failure in itself.

Being proactive in preventing ethical failure is thus an important factor to consider when judging the seriousness of ethical failures in organisations. Organisations that can demonstrate they are serious about preventing harm to their stakeholders will be judged very differently from organisations that take a lax approach to ethics, or that openly condone unethical conduct.

‘There is no substitute for openness’

However, despite the best intentions and attempts by organisations to prevent ethical failures, such failures still sometimes occur. And the result is always the same: both internal and external stakeholders are adversely affected. What matters then is how the organisation responds to such ethical failures, as this will determine whether stakeholders will be prepared to trust again, or feel even more alienated.

In fact, the ethical scandal is often not so much the initial incident that triggered the scandal, but the real scandal is caused by the way in which the organisation responded.

One of the most counterproductive responses to an ethical failure is to try covering it up. Organisations who try to hide their failures are not only mostly unsuccessful in doing so, but look doubly bad when the deception inevitably comes out. In the case of Arthur Anderson, their biggest failure was not their lack of auditor independence, but their attempts to hide and eventually destroy the evidence of their ethical failure. This is what ultimately lead to their demise as an auditing firm.

There is no substitute for openness on the way to recovery from an ethical scandal. Organisations can only restore trust if they come clean and admit their wrong-doing. It might seem counter-intuitive, but organisations who take their stakeholders into their confidence about what went wrong are more likely to regain the trust of stakeholders, than organisations who try to hide it from their stakeholders.

In this regard, organisations often find themselves between a rock and a hard place. They might realise that they have to disclose what went wrong to regain the trust of stakeholders, but are effectively forbidden from any such admission by legal advisors intent on avoiding legal liability and financial fines. Leaders and spokespersons of organisations then have to make the tough choice of which matters most: fines or fidelity.

‘Don’t mark your own homework’

Another important milestone on the road to recovery from scandal is not to frustrate the investigations that are likely to be instituted. Indeed, it is paramount that organisations give their full collaboration. In the case of KPMG, the firm has promised its full collaboration with the current investigation by the Independent Regulatory Board of Auditors (IRBA) into KPMG’s audit of the Gupta-linked company Linkway Trading.

The problem, however, is that IRBA will only investigate the allegations regarding audit irregularities levelled against KPMG, and not the allegations related to their advisory services, including tax advisory services to other Gupta-linked companies and their forensic report on the so-called ‘SARS rogue unit’. Currently there is no independent investigation on these non-audit related allegations of wrong-doing.  Rather, the investigation is being done by KPMG International (KPMGI).

This investigation by KPGMI – however rigorous in method it turns out to be – is doomed to suffer from a lack of credibility because of the relationship between the South African entity and its global parent.  The plain truth is that internal investigations never carry the weight of an independent investigation, because one cannot mark one’s own homework and expect others to take the result seriously.

This was very clearly demonstrated in the case of the Nkandla debacle, when President Zuma appointed a member of his own cabinet to run the investigation. The findings of then-Police Minister Nkosinathi Nhleko’s investigation were ridiculed and exposed as a cover-up. It could never enjoy the credibility that the findings of the independent investigation conducted by the Public Protector did.

Life beyond the scandal

Ethical scandals can destroy organisations, but they can also reshape and strengthen organisations. The global technology giant Siemens demonstrated this very well when, in 2007, it was convicted of large-scale tender corruption in various countries and paid the highest corporate fine ever recorded for corrupt practices. This plunged the company into the deepest crisis in its 170-year history. Yet, after that unfortunate incident, with its moral fallibility highlighted on the world stage, Siemens focused on building a resilient ethics and compliance approach to prevent corruption. Today, a mere ten years later, the company is regarded as a world-leader in internal corruption prevention.

We can only hope that similar stories can be told in future about the South African organisations who are currently embroiled in scandal. A long and arduous journey awaits them on the road to recovery of stakeholder trust. Sound ethical leadership and a reliable moral compass are essential equipment on this journey.

 

ENDS

 

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