Ethics and Compliance Committees of Corporate Boards

Source of Board Demands

Corporate boards face increasing compliance responsibilities and must consider how best to handle those responsibilities. There are various sources of the increasing burdens and pressures being placed on corporate boards. Among them are the traditional legal duties of due care, good faith, and loyalty placed on directors, with possibly severe consequences if directors fail to fulfill those duties. Included in the duty of care is the especially challenging duty of establishing and monitoring internal controls, the so-called Caremark duty, which lies at the heart of fulfilling the board’s compliance responsibilities. Many of the crises and scandals facing corporations in the past have resulted from a breakdown in those internal controls or the failure to even establish adequate controls in the first instance.

Other sources of the increasing compliance burdens placed on corporations include statutory duties created by the Sarbanes-Oxley Act, incentives created by U.S. Sentencing Commission guidelines, along with charging guidelines by regulatory agencies, conditions imposed by deferred prosecution agreements, board supervision of corporate crisis management, increasing ethical demands imposed on the corporation, and reports sent to the board by senior executives in compliance and ethics. In cases of major corporate crises, the question is often asked, “where was the board?” In the Volkswagen case of cheating emissions software, the information never surfaced to the attention of the board for a period of ten years, and almost the same was true of the ignition switch failures at General Motors. The massive gulf oil spill by British Petroleum followed mistakes made by the board in the pre-crisis stage, when it failed to supervise implementation of an announced safety culture in the company.

Consequences of Failing to Meet Demands

Failure to fulfill any of those duties and failure to respond to legal incentives might lead to three major consequences. First, criminal and civil lawsuits targeting the corporation and either the board or specific members and committees of the board might follow. Secondly, investors might vote against the retention of specific members of the board and board committees, following the advice of shareholder advisory firms like Institutional Shareholder Services and Glass Lewis, which recently advised against the retention of a key board member of the Wells Fargo corporate responsibility committee. Finally, the failure of directors to diligently fulfill their responsibilities in ethics and compliance could lead to the board ousting and replacing such members.

Role of Board Audit Committee and Ethics & Compliance Committee

Given the growing number of legal compliance demands placed on the board, along with possibly severe consequences for failing to meet those demands, the question of how a board can best assume its responsibilities becomes more compelling. Traditionally, the board-level audit committee has assumed these responsibilities. However, that committee might be overburdened in some companies, especially given the mounting demands it must fulfill. When examining posted committee charters on company websites, it is not uncommon to find that audit committees meet eight or more times a year, versus less than half that number for other board committees. A second concern is whether the audit committee has the requisite skill set to meet its increasing duties to monitor ethics and legal compliance.

To answer this important question, I studied the memberships of the audit committees of the Fortune top 20 companies and compared them to the skill set of members of the 12 board committees that seem to assume the responsibilities of a genuine ethics and compliance committee. Those committees exist under different titles, but I read the charters of all similarly labeled committees of Fortune top 100 companies to ascertain which ones actually took seriously the role of an ethics and compliance committee, and there are only twelve. There are four each in the pharmaceutical, financial, and energy sectors. The results of the study are published in the summer 2017 issue of Corporate Control and Ownership, a leading journal on corporate governance.

Findings of the Study

The comparative findings are illuminating. First, regarding education and experience, only 8.4 percent of audit committee members have a law degree (J.D.) and legal experience, while 24 percent of the members of ethics and compliance committees have such a background. Secondly, while 15.7 percent of audit committee members have government or regulatory experience, fully 30 percent of ethics and compliance committee members have such experience. Finally, in terms of power and level of corporate experience, while 12 percent of audit committee members are present or former CEOs, 54 percent of ethics and compliance committee members have that type of high-level experience in the C suite. On the less important issue of prior or current non-profit experience, more members of ethics and compliance committee had such experience than did audit committee members.

On the basis of these findings, it is reasonable to conclude that members of ethics and compliance committees have more relevant backgrounds to monitor legal controls than do members of audit committees. Though the backgrounds of the latter might be sufficient to monitor financial performance, they do not measure up to what is required to monitor broader internal controls and to monitor overall compliance on a broader range of risks. Members of ethics and compliance committees are also probably better able to empathize with the mindset of government regulators and possibly even have intelligence sources within those agencies. Finally, and perhaps most surprisingly, members of ethics and compliance committees have far more C-suite experience than do audit committee members, perhaps giving them an appropriately strong voice in board deliberations.