Royal Commission shows tone from the top is silent

The Royal Commission must investigate failures of Corporate Governance in the big Australian banks.

Like a grand Verdi opera, the Royal Commission (RC) into Misconduct in the Financial Industry is moving inexorably towards its climactic final act (or, in dry legal terms, Round 7).

The Commission may not end with the traditional ‘fat lady singing’ but likely with a parade of bank CEOs being wheeled in, to be publicly eviscerated by the Commissioner, Justice Haynes, and his ferocious counsel assisting, Rowena Orr QC.

[Note An edited version of this article appeared in Australian Banking and Finance on 16th September 2018.  Many thanks to editor Elizabeth Fry.]

However, unlike tragedies such as Aida or Rigoletto, there will be no operatic blood-letting in the final act but, having read the interim report of the RC due to be published in late September, a few CEOs may choose to fall on their proverbial swords.  Some banking regulators might also wish that they had booked a trip to an overseas central banking conference, for the same week.

It is right and proper that the public and the victims of the disgraceful scams brought to light by the RC, should get an opportunity to listen to the chorus of the senior managers involved, if only to hear another round of apologies and promises that behaviour will be better in future. It will indeed have to be better in future, because it couldn’t be much worse, as some shareholders in the institutions implicated in the misconduct, have already discovered.

But there is a group of people from whom little has been heard during the commission’s proceedings – the members of the Boards of Directors of these institutions, especially the Four Pillars of Australian banking, which have appeared as villains in all of the commission’s proceedings.  These banks have: recklessly loaned money to people who could not afford to repay; charged clients for services not provided; charged fees to dead people for advice; failed to deal properly with indigenous customers; and have even been accused of criminal conduct.

By virtue of turning up egregious, unacceptable, and even illegal, misconduct in several areas of banking and superannuation in all of the major financial institutions, the RC has unearthed some of the greatest failures of ‘corporate governance’ since the failure of HIH Insurance in 2001. In fact, the governance failures by the boards of the major banks today far eclipse those of the directors of the failed HIH Insurance.

It should also be remembered that there are other governance failures that exceed even those unearthed by the RC, which by its terms of reference is required to consider only open issues and ignore examples of misconduct that had already been settled. For example, cases of the manipulation of the BBSW and Forex benchmarks by the big four banks which were settled with ASIC, are not to be considered. These followed the largest monetary settlement in Australian banking history between the New Zealand Inland Revenue and the NZ subsidiaries of all of the Four Pillars. Individual banks also paid huge fines for misconduct, such as CBA paying some $700 million to settle with AUSTRAC for violations of money laundering laws.

The final report of the Royal Commission into the failure of HIH [yes, there was a previous but much narrower commission into financial misconduct] gave a good but dry, legal description of corporate governance as “the framework of rules, relationships, systems and processes within and by which authority is exercised and controlled in corporations. It includes the practices by which that exercise and control of authority is in fact effected”. This definition has proved so good it has been used in the latest draft ‘Corporate Governance Principles and Recommendations’ issued by ASX.

The ASX document identifies the role of the Board in good corporate governance and in its Principle 1 requires that “A listed entity should clearly delineate the respective roles and responsibilities of its board and management and disclose how their performance is monitored and evaluated”. This first principle then lays out a slew of board responsibilities, such as “demonstrating leadership” and “appointing and replacing the CEO”.  Two responsibilities of a board are particularly important in the context of misconduct: “overseeing management in its implementation of the entity’s business model, achievement of the entity’s strategic objectives, instilling of the entity’s values and performance generally”; and, “monitoring the effectiveness of the entity’s governance practices”.

Pretty straight forward – the directors are ultimately responsible to shareholders for the operations of a company.  It is pretty clear that the buck stops at the board. But what happens when the buck stops spinning on the boardroom table?  Precious little, apparently.

How boards actually exercise their governance responsibilities is usually shrouded in secrecy, under a dubious claim of ‘commercial in confidence’. Rarely is the veil lifted, save, for example, when a firm, such as HIH, fails.  However, earlier this year, after the announcement of the CBA’s money laundering failures, APRA outsourced its responsibilities for investigating the bank’s governance problems to an expert independent panel.

The independent panel had free access to board deliberations and its final report was devastating in its critique of the passivity of the board in the face of executive management,

“The Board [of CBA] and its Committees exhibited a high level of trust and confidence in management driven by recent financial success and a collective belief that CBA is well-intentioned, conservative by nature and customer-centric. The Panel’s view is that these factors contributed to a level of complacency and a ‘dulling of the senses’ within the Board and its Committees to signals that might have otherwise alerted them to a deterioration in the risk profile, and a movement outside of the risk appetite of the Group.”

In other words, the CBA board did not fulfil its primary role of protecting their shareholders’ interest in the face of management pushback.

Now it entirely possible that the CBA board was/is the only one of the Four Pillars banks to have a deficient corporate governance framework.   However, evidence presented in the RC and earlier cases of misconduct, strongly suggests that there might be similar failures to implement appropriate and effective corporate governance frameworks in the other three Pillars.

So, if one is looking for the sources of misconduct in a bank, one must look at governance frameworks and the persons responsible for ensuring the effectiveness of governance – the Board.

There is a precedent beyond HIH, for requesting board directors to appear before a body similar to the RC – the UK Parliamentary Commission on Banking Standards (PCBS).  The mammoth investigation by the PCBS, which examined the causes of UK bank failures during the Global Financial Crisis (GFC), hauled many of the CEOs and Chairmen (no women) of banks before it, usually in pairs to prevent finger pointing.

One case study in particular, the failure of Halifax/ Bank of Scotland (HBOS),  highlighted the problems that brought a once great bank to its knees, “The HBOS story is one of catastrophic failures of management, governance and regulatory oversight”, and with echoes of the CBA inquiry, “The corporate governance of HBOS at board level serves as a model for the future, but not in the way in which Lord Stevenson [Chairman] and other former Board members appear to see it. It represents a model of self-delusion, of the triumph of process over purpose.”

To get to the bottom of the ills that have befallen Australian banks, the Royal Commission should ideally insist that bank CEOs are accompanied to the Commission by at least the Chairs of their Boards of Directors and should also consider calling the chairs of the banks’ Risk Management Committees, which have so spectacularly failed to properly exercise their responsibilities.

Australian banks and regulators cannot claim they were not warned. Fifteen years ago, HIH Commissioner, Justice Owen, cautioned “HIH is a reminder, if one is needed, that a drastic fall from corporate grace can occur if those in charge lose their way”. Unfortunately, those wise words were forgotten by the industry.