Audit Committee Bulletin: January 2014

Raising the standards of ethics and compliance

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With regulators getting tougher on business wrongdoing and a minority of employees tempted to cross ethical lines to meet targets in difficult economic circumstances, ethics and compliance programs have become prominent on boardroom agendas across Europe.

How boards and audit committees should share the effort to review and improve standards on ethical behavior and compliance remains open for debate.

Some companies have put ethics and compliance on the main board agenda. This can be an effective way to keep senior executives engaged. Others have created a new committee to deal specifically with the issue.

The audit committee’s role

Even when the audit committee is not fully responsible for ethics and compliance oversight, its members need to understand how well the business manages risk in this area.

The European Union’s 8th Directive requires the audit committee to monitor the effectiveness of internal control. To do so, it needs a clear view of the ethical and compliance culture in the business.

Managers behaving unethically typically have a direct effect on the company’s underlying financial and accounting information. This is an issue at the heart of the audit committee’s traditional role.

How much a company spends on compliance is less important than how well its compliance program nurtures an ethical culture.

Lifting standards

Companies can use incentives to encourage ethical behavior and reduce compliance risks. However, the company’s culture provides a more constant and equally powerful influence.

Successful programs share four key elements:

  • Leadership. The board and senior executives must set the right tone at the top.
  • A code of conduct, backed by training. Employees need to understand the rules.
  • Zero tolerance. Employees need to know they will be disciplined or fired if they break the rules, and companies should be prepared to leave a market where doing business ethically becomes too difficult..
  • Monitoring. Good information identifies violations and highlights areas where training or guidance is needed.

Need for a whistle-blower system

A whistle-blower hotline, often an integral part of a company’s efforts to stop bad behavior, gives people a confidential way of sharing their concerns.

But hotlines are not always effective. European Union laws, and some national laws, can limit a company’s ability to offer a hotline, including who can use it and the kinds of concerns employees can raise anonymously. Laws can also restrict a company from outsourcing its hotline.

Other challenges arise when companies fail to offer meaningful rewards or incentives to whistle-blowers, or when they don’t have people with the forensic skills or independence needed to follow up concerns properly.

A whistle-blower system can generate such a large volume of alerts that just addressing the issues raised can pose its own difficulties for the audit committee.

The audit committee has a clear role to play in helping identify and manage the associated risks surrounding ethics and compliance..

Questions for audit committees