The consequences of inadequate control
Let’s first look at a historical example of how bad it can really get, and why boards (chairs, in particular) need to be on top of their employment responsibilities. This goes to the heart of their ability to direct, control and assure the wellbeing of their organisations. I refer to a case in the early 1990s of an Australian not-for-profit organisation—the National Safety Council (Victorian Division). It is as extreme a case as I have come across. At one level it concerned an out-of-control (and, as it turned out, dishonest) chief executive. What happened, however, was a direct consequence of inadequate financial control by the board.
The board had given its chief executive broad authority to enter into contracts on behalf of the organisation, including to negotiate and execute agreements with financiers to provide working capital. During the last four years of its operation, the organisation had financial facilities with no fewer than 27 different banks or financial institutions.
To get the board’s approval for these transactions, the chief executive typically did no more than assert orally at board meetings that they were necessary. He provided no explanatory documents—either in advance or at all. The chief executive sometimes sought the board’s approval before he committed the organisation to a finance contract. More often, he asked the board to endorse a fait accompli. When the board ‘approved’ the chief executive’s proposals, it recorded its decisions in only the broadest and vaguest terms.
The transactions concerned were so frequent, numerous and diverse, and the amounts involved so large, that it was difficult for directors to keep track. It was hard for them to have any proper appreciation of the true nature and total amount of the organisation’s borrowings. The board was further restricted in its understanding of the organisation’s financial position by the inadequacy of the management accounts presented to it.
The short version of a very long story is that the not-for-profit National Safety Council ended up with a $250 million debt that it could not repay. Court action followed, as lenders attempted to recover their loans.
The board chair chose to fight the Commercial Bank of Australia’s attempt to recover its debt in Court. Essentially, he depended on the ‘I’m just a volunteer’ defence. Unfortunately for him, the Supreme Court of Victoria did not buy the idea that being a volunteer on a board (particularly in a leadership role) somehow excuses weak governance. The Court underlined its lack of regard for poor governance—for which it clearly held the chair accountable—by making a judgement against him of over $96 million!
The Court acknowledged that its judgment would seem severe, but its reasoning was threefold:
- While the chair was a victim of the chief executive’s extensive fraud, the size of the award was no more than a reflection of the size of the debt actually incurred by the organisation.
- If the chief executive’s fraud was extensive, so also was the chair’s failure to monitor the organisation’s financial position, which allowed the fraudulent borrowing of enormous sums that it could not possibly repay.
- There may have been grounds to think that the bank had been imprudent in making the advances it did to the National Safety Council. However, the law did not distinguish between a wise and a foolish lender. The fact remained that the organisation had incurred the debt and benefited from the funds provided.
The board failed to direct and control its chief executive properly. It was, therefore, unable to exercise its fundamental duty of care. The Court also observed that the National Safety Council been seeking to act as a commercial entrepreneur. But its legal structure (a company limited by guarantee with no share capital) was inherently unsuitable for the conduct of the business in that manner. [2]
The risks of sweetheart deals
The New Zealand example that prompted this article concerns a charity involved in funding research and education in the health sector. Its travails came to light because a 2015 inquiry by Charities Services, part of the Department of Internal Affairs, was finally forced into the open by an official information inquiry. The case, initially triggered by staff complaints, did not involve the same kind of chief executive malfeasance as in Victoria, but there was similar poor governance. When this emerged, it cast a shadow over the chief executive and others complicit, as well as the organisation.
As in the National Safety Council case, issues were both structural and performance-related. Governance of the charity was divided between two bodies. One was a ‘council’ responsible for making all policy decisions relating to the management and affairs of the organisation. The other was an ‘executive committee’ that managed the day-to-day affairs of the organisation and made policy recommendations to the council. Unfortunately, governance structures like these—confusing accountabilities and creating cumbersome decision-making processes—are not uncommon in New Zealand.
The likely contribution of the structural issues to the problem was not central. The catalyst for the Charities Services intervention was, in effect, staff concern about the chief executive’s behaviour. This led to questions of improper (illegal or corrupt) expenditure of the charity’s funds and dereliction of the Council’s fiduciary duties (the ‘duty of care’ issue again).
Staff whistle-blowers pointed to a flawed process for approving and accounting for international travel and related expenses for the chief executive and his wife. Those expenses might have been considered an unjustified benefit, given the purpose of the charity—and possibly even unlawful.
The chief executive was also out of the office a great deal—much of the time on the golf course. Attention to this perceived neglect of his duties uncovered another undesirable arrangement. He had also been receiving an increasing bonus paid in leave instead of cash. The practice was rationalised as ‘keeping the paid budget down’ and ‘avoiding the public relations barrier of reporting the payment of high salaries at a charity’. News reports quoted the chief executive as saying that taking (untaxed) leave was also consistent with his ‘anti-tax’ principles.
Eventually, the 2015 investigation concluded that there had been evidence of ‘gross mismanagement’ (including poor record-keeping), but the charity had not made unlawful use of funds.
It turned out that these various questionable arrangements were a product of bilateral agreements between the chair and the chief executive. A subsequent chair of the charity told investigators he had inherited the chief executive’s generous, informal golfing leave arrangement with from his predecessor. He did not think about it until the Charities Service Investigation made him look at it more closely and conclude that it wasn’t right.
If the full board had been able to pay proper attention to the arrangement, it is unlikely it would have been approved. Someone on the board would have undoubtedly questioned ‘the look’ of it. A charity committed to raising funds from the public to apply to ‘good works’ cannot afford to run the risk of alienating donors and staff alike. Let’s be realistic though; there is often pressure on board chairs to do sweetheart deals with their chief executives. To avoid this, and to protect both individuals, executive remuneration and benefits should be visible to all board members. [3]
Unaccountable boards and directors can do great harm
In both these cases, ineffectual governance and employment practices allowed boards to create existential risks to their organisations and cause great harm to individuals. In the National Safety Council case, the chair was bankrupted, and the chief executive committed suicide. In the New Zealand charity case, significant reputational damage was done both to the organisation and leading individuals in it.
Although the refrain ‘but we’re just volunteers’ is still regularly heard, it has had its day as an excuse for a lack of board and director performance and accountability. Performance expectations and regulatory requirements have increased, and governance training and advice is readily available. One of the Victorian Court’s most telling comments was to the effect that ‘if you accept a board position you have implicitly given an undertaking that you can discharge the responsibilities that go with the role’.
I wonder how many of our boards and directors—particularly those who consider themselves ‘just volunteers’—are in over their heads and are unaware of it?
Notes:
1. I have chosen not to identify the organisation concerned even though the information I have referred to is in the public domain. The chief executive and relevant board officers concerned are long gone from the organisation and from its current website, it seems that significant changes have also been made to the governance framework. The National Safety Council in Australia is also now a fundamentally different organisation to the one described 30 years ago.
2. Readers wanting to learn more about this case are referred to COMMONWEALTH BANK OF AUSTRALIA v FRIEDRICH & ORS, Supreme Court of Victoria, 03 July 1991
3. In a well-known statutory authority I have become familiar with, this problem is endemic. A federally structured organisation with several self-governing regional sub-entities, it features wildly different and unsubstantiated levels of remuneration at the regional manager level. The differences in remuneration between broadly similar sized jobs can only be evidence of the undue influence some managers have over their boards. In at least one of those regional bodies, the regional manager has convinced his chair to keep the details of his remuneration secret from other members of the board.
