Mythical Pendulum Isn't Swinging Back The Other Way

I’m frequently asked when the proverbial pendulum will swing back and business-bashing will cease. My unpopular response is: What we’re seeing is real and isn’t going away. A lot of credibility the business community once had has been squandered and eroded. It’s going to take a lot of time and effort to rebuild that credibility.

Don’t make the mistake of thinking that Election Day’s results will lead to the repeal or modification of the regulatory requirements enacted to date, or a slow-down in the promulgation of new regulations. Too much damage has been done by the progression of scandals and transgressions that we’ve all witnessed—and unfortunately continue to witness—and restoration of the public’s confidence will continue to be used to justify the adoption of more and more regulations.

Worse, focusing on a mythical pendulum loses sight of what’s really important. Many companies and their advisors assume the reason they need to improve their governance, policies and procedures is the initiatives of legislators, regulators and prosecutors. That’s wrong. While adherence to statutory and regulatory fiats is necessary, it’s not sufficient. Those who strive to do no more than the minimum to pass muster risk becoming enmeshed in the same mess as so many other corporate managers who’ve preceded them. Put another way, it’s in corporations’ self-interest to look beyond specific legislative and regulatory mandates, and think about effecting real governance and transparency reforms. Here’s why.

Extreme adverse economic and reputational damage flows from regulatory action. This is perhaps best illustrated by the case of Marsh & McLennan, which has now had a triple-drink from the scandal fountain. Its Putnam mutual fund unit permitted late trading and market timing by select customers, even as it publicly asserted such practices weren’t allowed. The result, in addition to federal and state regulatory proceedings, was the loss of nearly $60 billion in assets under management.

Then, Marsh’s Mercer compensation consulting unit was embroiled in the NYSE’s controversy over Dick Grasso’s compensation. Mercer avoided criminal prosecution by settling.

Now, Marsh’s insurance brokerage unit has been accused of price rigging and bid rigging, resulting in a drastic overhaul of the company’s senior management, and a precipitous decline in the company’s market cap.

Even beyond the harsh consequences of being “Putnamized” and seeing critical financial support withdrawn, there are enormous pressures on corporations—pressures ignored only at one’s peril.

Regulators, like nature, abhor a vacuum. The recent activism of New York’s Attorney General demonstrates the time-honored scientific principle that nature abhors a vacuum. If Marsh brokers really did procure companies to submit sham bids, could anyone have failed to recognize that conduct of that nature was fraudulent? I certainly hope not. But why did it take Elliot Spitzer to uncover and pursue this behavior? What steps had Marsh taken, before its latest problem surfaced, to discover potential misconduct or fraudulent behavior?

Most companies are content to assume the wisdom of the old saw, “if it ain’t broke, don’t fix it.” That’s just plain wrong in today’s regulatory and prosecutorial environment. If companies were attentive to the possibility of chicanery, fraud, conflicts of interest, greed, and other malevolent conduct—and took steps to ascertain whether it existed, and if it did, to eradicate it—there’d be little or nothing left for regulators to do. Instead, regulators are filling the vacuum.

Every day there are lessons begging to be learned. For example, investment bankers need to be wary of raising capital for companies with higher risk profiles. Their fees pale in significance to litigation and settlement costs if they select an unethical client. They’ve learned—the hard way, via settlements with the SEC and civil litigation—that there’s danger in raising capital for companies with higher risk profiles.

The concept of due diligence now has new meaning, and bankers need to learn that, in addition to their own due diligence, they need assistance in ascertaining for which of the people who walk through their doors it’s prudent to raise capital. They’ll need assurance there’s a small likelihood that, by raising capital, they’ll wind up paying out multiples of fees earned in settling class actions and SEC litigation. This means not every company will be able to raise funds at the public trough, or even borrow money.

Growing numbers of investor portfolios focus on companies that are responsible, ethical, and run by people with integrity. There is growing evidence that companies able to demonstrate they’re responsible, ethical and run by people with integrity significantly outperform their core peer competitor groups.

More than any government regulation or prosecution, this is the factor that must drive the push toward better governance, more accountability, and greater transparency. This factor creates a need for strong internal governance at public companies, and the ability of public companies to distinguish themselves from the pack. What we’re seeing is a new form of “Corporate Darwinism,” where only the fittest companies with the best governance survive and prosper.

Whatever the government does or doesn’t do, businesses must take the initiative in policing or cleaning up their own acts. Investors, lenders, investment banks, D&O insurers, rating agencies, accountants and socially responsible investors must be confident that a company has told them everything they need to know to make an accurate assessment of a company’s current performance and future prospects. Access to capital, the increased willingness of other companies to do business, and the ability to obtain and retain quality directors, are—and should be—the rewards for going beyond merely complying with federal regulatory requirements.

A company’s reputation is its most valuable asset. A reputation takes years to develop, but only seconds to squander. It can be created and preserved only if compliance is an integral part of a company’s business model. Compliance and legal functions must work hand in glove with business units. Companies must resist the temptation to cut back, or skimp, on compliance assurance, especially in times of economic difficulty. Compliance and legal staff contribute to the bottom line in the most important way possible—they assure that firms can retain and improve their reputations.

Be honest. As science-fiction writer Arthur Clarke reminds us, “The best measure of a man’s honesty isn’t his income tax return. It’s the zero adjust on his bathroom scale.” Businesses need to examine and re-examine their current practices and make an honest evaluation about whether they continue to be compliant in the current environment. Saying, “We’ve always done it this way” is no defense.

There’s no safety in numbers. Businesses should resist the temptation to try to push the envelope by getting their lawyers and accountants to sign off on nuanced practices that don’t necessarily reflect the spirit of the law. Be honest. Zero your scale. If not, the consequences will be severe, and the approval of outside professionals will not sway regulators and prosecutors one whit.

This is the new reality; it isn’t a trend. Nor is it the pendulum swinging in one direction, with the promise that it will eventually swing back. It’s reminiscent of the story of the 4-year-old whose parents brought home a new baby. Her grandparents also arrived to help out for the week, at the conclusion of which, as they packed their car to leave, the 4-year-old came running out and exclaimed, “You forgot your baby!”

This baby is staying.