More corporate downfalls and scandals

Strong corporate governance is of critical importance when it comes to mitigating D&O risk. More generally, it is also important for providing a platform on which to build a long-term successful business. Despite this being well understood and appreciated by many, we can be sure every year that there will be corporate scandals and downfalls that cause damage to a great number of people, and the organisations themselves, and their employees (not to mention the potential follow-on D&O loss!).

Whilst there is a certain level inevitability to this, there are always lessons that can be learned from these situations. With our perspective as D&O practitioners, we have picked three scandals that hit the headlines in in 2022 and 2023, and provide us with useful lessons and reminders relating to corporate governance, and the role it plays in the success or otherwise of an organisation. 

The P&O Ferries UK Scandal

This case serves as a reminder that the way in which a company handles its relationship with its employees can have serious knock-on effects on company reputation, and can lead to D&O litigation/investigations. 

On 17 March 2022, P&O Ferries dismissed 786 crew across its entire fleet, without prior consultation, via a video message, with immediate effect, due to redundancy. The reasoning for the decision was in part to secure the future viability of the business. However, the manner in which the redundancies were handled caused a media storm and drew mass public and political condemnation. Much debate followed regarding the legality or otherwise of the redundancy process, and many commentators (following statements made by the CEO) concluded that the board of P&O had intentionally and consciously acted in breach of applicable employment laws.

What followed included questioning of the P&O CEO by a UK Parliamentary Committee, and investigations by the UK Insolvency Service. It was confirmed in August 2022 that a criminal prosecution would not be commenced but that a civil investigation into the debacle was ongoing.

At a time where companies are facing difficult decisions during a time of financial uncertainty, the P&O Ferries case also provides us with a good example of the intersection between the interests/survival of the company, and the rights of/relationship with its employees. Further, it provides an interesting example of where apparent technical compliance with applicable laws (in this case international maritime laws) is not enough to prevent severe reputational damage and fallout. 

This sort of event with respect to employees can lead to regulatory investigations, criminal prosecutions, employee claims (unfair dismissal claims), damage to reputation, and fines. Deliberately and consciously choosing to break the law can also have a knock-on effect on the recoverability of loss being claimed under any D&O policy.

In August 2022, the UK Insolvency Service announced it would not be pursuing a criminal prosecution, although the civil investigation remains ongoing. We await the outcome of the Insolvency Service civil investigation.

For more on Employment related risks and exposures for Ds&Os, check out episodes 14 and 15 of The Rising Edge D&O Podcast in which we discussed these issues with experts from the law firm DAC Beachcroft.

The Downfall of FTX Trading Ltd

If there is something we have learned from the Enron, Worldcom, Allen Stanford, Bernie Madoff Investments, and Wirecard scandals, it is that history repeats itself, and that large scale frauds and/or irregular and illegal accounting practices seem to exist and operate in plain sight until an event or series of events occur that trigger a liquidity crunch for the relevant company, causing it to fail. It all seems so obvious afterwards, doesn’t it?!

In November 2022, the world’s third largest cryptocurrency exchange, FTX Trading, filed for Chapter 11 bankruptcy protection in the United States. At that point in time, press reports were suggesting that the exchange might have a shortfall of as much as $8bn.

The new CEO of FTX, John J. Ray III (who was also involved helping to manage the fallout from Enron) said: “Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here”. He also commented that control was in the hands of “a very small group of inexperienced, unsophisticated and potentially compromised individuals”.

Whilst FTX is an extreme case study, what can we all learn (or be reminded of) from this the newest poster child of corporate failure and collapse?

  • As a starting point, the true company culture and values that exist (i.e. not just those just stated on a website), inform the approach a company takes to corporate governance managing its risks. In this case, the culture appears to have been one in which making money and profit usurped any consideration of risk, ethics or oversight. A healthy company culture values oversight and ensures accountability. This starts at the top, and appears to have been absent at FTX, and was a factor in the collapse.

  • FTX was run by a small group of inexperienced individuals operating with little or no independent oversight. Further, it apparently operated without any board at all at group level (i.e Holdco level), HR, Legal, Accounting or Compliance departments. It is therefore no surprise to see it collapse into bankruptcy the way that it did. First, an experienced, competent, and diverse board of directors who place integrity at the centre of the business no doubt would have implemented the processes, procedures, and controls which would have mitigated against the risk of such a sudden a catastrophic collapse.  We also question what influence or role a suitably qualified independent non-executive director could have brought to this situation? They are there to provide independent oversight, to ask the difficult questions of the board, and to challenge the board with respect to the implementation of the business strategies.

  • Talking of independence, FTX also operated without an independent oversight of the board by an internal audit department, another important function in a company as large as FTX.

  • Beware the messianic CEO! This is related to company culture and values, and the presence of the messianic CEO can be a factor in creating a culture in which people are fearful to speak up or have no process in available to them by which to do so. There must be a way for unsightly practices to rise to the top and then be acted upon accordingly.

  • It was recently reported that FTX had located more than $5bn of assets (consisting of cash, liquid cryptocurrency, and liquid investment securities). Whilst this still leaves a $8bn shortfall, it is astounding (but not surprising given the lack of any accounting controls) that this amount of assets appears not to have been traceable at the point of FTX entering chapter 11.  Corporate governance is not just the bedrock of a generating company value, but it is also critical to a company’s resilience and it’s ability to survive or weather unexpected events. In the case of FTX, unexpected developments happened, and the company collapsed, at speed.

  • It is also noteworthy given the current fervour around ESG and ESG ratings that prior to the collapse, ESG ratings company, Truevalue Labs, gave FTX a higher score on ‘leadership and governance’ than Exxon/Mobil. This is hard to reconcile with the statements of the current bankruptcy court appointed CEO referred to above and. A reminder to us that ESG ratings do not necessarily correlate with D&O risk.

  • Any finally, once again, we are reminded, when something seems too good to be true, it normally is.

The Downfall of Silicon Valley Bank

What did Silicon Valley bank have that FTX didn’t? Well; it had a proper board of directors, an audit committee, a compensation and human capital committee, a finance committee, a governance and corporate responsibility committee, a risk committee, a technology committee, a code of conduct, and corporate governance guidelines. It failed because of an old-fashioned bank run.

What are the lessons here for Directors of commercial entities?

  • The first is that we should all be thinking about and looking to mitigate counterparty risk. Many companies may bank with a single financial institution. This leaves a company exposed to a single point of failure like the one that occurred to SVB. Companies should be considering how the risk here can be diversified among other institutions.

  • Counterparty risk is broader than just banking – think customers, supply chain/ suppliers, trading partners, 3rd party vendors… the list goes on. How is the company diversifying its risk to a single point of failure. 

  • What and how you communicate to the world at large in the moment of a crisis is critical. The natural urge may be to try to provide all of the answers at once, and to release them as early as possible. A more strategic approach could have been more prudent in this case.

For more on proactive strategies regarding public communications and disclosure, check out episode 1 of The Rising Edge D&O Podcast in which we discussed these issues with experts from the law firm Paul Weiss.

Previous
Previous

The Rising Edge Challenge Cup

Next
Next

The macroeconomic environment