Notes on a scandal

For the political classes, parliamentary select committee hearings are something akin to gladiatorial combat for the modern age. These hearings make for great spectacle and gripping human drama with the crowds baying for the killing blow to be delivered.

In July, it was the turn of Rupert Murdoch and his son, James, to play the part of villains before the select committee over their part in the phone hacking scandal at News of the World, the Sunday tabloid published by News International, the UK division of News Corporation. Many of the assembled committee members failed to land any meaningful blows, but the hearing still delivered much of the drama for which everyone had hoped, sending the twitter-sphere into frenzied activity and leaving Murdoch – quite literally – with pie on his face.

Murdoch’s performance during the two-hour hearing made the media mogul appear a diminished figure. It was described by many commentators as his Wizard of Oz moment: the one in which his previously all-powerful image was exposed to reveal the frail reality behind it. But the answers Murdoch provided were perhaps more important than even the sight of the mogul appearing to be so out of touch and out of date. He was grilled by MPs about how phone hacking had flourished in his UK newspapers, why his company is alleged to have paid £100,000 to police officers, and why two people in his pay have been jailed.

However, the overriding impression for much of the hearing was that neither father nor son knew very much at all about what was going on at News of the World. Indeed, it seemed like the most common words coming out of their mouths were, “I don’t know.” Whether the repetition of these three words can be put down to strategic mendacity, the fuddled answers of an octogenarian in the case of Rupert, or the simple reality of running such a sprawling and complex organisation, one thing is clear: the response reveals a total breakdown in the corporate governance of News Corporation.

System failure

Murdoch’s defence was simple: the tabloid represented less than 1% of his media empire and he employs 53,000 people around the world. The essence of Murdoch’s argument – an argument that was supported by his son James – was that, as chairman and CEO of a global company, he was much too busy and far too removed from the coal face to have known about ethical lapses at one of his newspapers.

This defence gives rise to a number of questions. If the alleged claims of police corruption are found to be true, the chief question is why these ethical lapses took place and what kind of corporate governance culture could allow such widespread failures. The argument that these were the actions of a few rotten apples appears to hold little, if any, credence.

Implementation of good corporate governance procedures and a strong ethical culture is an area in which the board, chief executive and finance director have to take a leading role. It could even be argued that the crisis could have been easily avoided if these elements had already been present.

“The board and senior management have a responsibility for ensuring risk management and adequate internal controls are in place,” says Paul Smethurst, head of the forensic and investigation team at accountancy firm Carter Backer Winter.

If Murdoch’s claims that they simply did not know what some of their reporters were getting up to is taken at face value, it is clear that News Corporation’s internal controls were either inadequate or had broken down completely.

“For any organisation looking to avoid the issues that have occurred at News International, the key is having an effective system of control,” says Ian Peters, chief executive of the Chartered Institute of Internal Auditors. “If we believe the executives at News International, we must assume that these controls were exercised down from the top. They say they didn’t know what was happening on the ground. The corporate governance and system of control clearly wasn’t working.”

During his grilling at the select committee, Murdoch conceded that he was focused on his US media interests and that he had “perhaps lost sight” of what was going on at News of the World. He even admitted that he spoke to the editor “very seldom”. According to Peters, it becomes even more important that a company has an effective internal audit function in a hugely complex organisation like News Corporation. It is quite reasonable to accept, he says, that the “board cannot be expected to know everything that is taking place on the ground. You need a global internal audit to provide information and advice to the board.”

It is only natural for someone in Murdoch’s position to have taken a step back from the day-to-day decision making and running of the business. He needs to oversee a huge business that operates in publishing, cable network programming, satellite broadcasting and filmed entertainment. Eric Tracey, a former FD at Amey and Wembley who is now a senior non-executive director at Chloride, says that this means Murdoch’s engagement appears to have eventually become “erratic and peripatetic”.

In response to such a situation, it is vital that internal audit should play a crucial role in reporting back to the board and management about the adequacy of internal controls. Equally, a vigorous and robust internal audit must send a clear message to the board about the adequacy of risk management procedures.

If a company has both a clear procedure and clear reporting guidelines that devise controls to manage that risk in place, the top management will not be required to be everywhere all of the time.

“Sometimes he will be right on top of a particular part of the business, but it is hard to tell whether or not he is on top of the business everywhere,” says Tracey. “If you have someone who is so dominant, you would think that the audit function would need to have contact with that person. And the challenge is to be aware that the audit function only gets so much time with someone like Rupert Murdoch.”

Tone from the top

While it is impossible for management to sit perched on the shoulders of every employee to make sure their orders are discharged in an effective and responsible manner, it is the responsibility of management to set the corporate culture and the values by which executives throughout a group will behave. In this instance, the comments by Murdoch are quite revealing.

“I feel that people I trusted – I’m not saying who, and I don’t know what level – have let me down. I think they behaved disgracefully and betrayed the company, and me,” he told the select committee.

But if more attention had been given to so-called tone from the top, this perceived “betrayal” could have been prevented. Tracey certainly thinks so. He points out that the importance of the tone from the top – in such infamous examples of value destruction as Enron, Worldcom, Lehman Bros, Northern Rock and, in a different way, BP – has attracted a lot of attention. News International would have done well to learn from the high-profile calamities that have gone before.

“Tone is palpable,” says Tracey. “It picks up on what is tolerable. Pressure is put on staff to get results, and they will find a way of doing it. You can interpret that as something to be achieved within the rules, or by any means necessary. Tone conveys message. It does make a difference and it can only come from the top.”

There is no doubt that the journalists working at News of the World, like journalists working at any number of newspapers and broadcast media, were under intense pressure to break the stories and hit their deadlines. However, it appears that the approach taken at News of the World was that this should be achieved by any means necessary.

Smethurst points out that it is worth noting the general characteristics of an environment in which corruption can thrive, as the Bribery Act 2010 came into effective from 1 July. He mentions the incentivised environment that promotes getting results (and rewards) whatever the cost; the opportunity for fraud or corruption afforded by weak systems or management; the rationalisation that it is OK as everyone else is doing it; and the expectation that there is little risk of being caught or, if you are caught, that there will be no consequences.

Once again, the environment will be a result of the tone exhibited by the management.

“This was very usefully illustrated by the statement Murdoch made to the select committee,” says Smethurst. “He said that the management now know things went badly wrong, and [following the conviction of royal editor Clive Goodman and private investigator Glenn Mulcaire for phone hacking in 2006] thought the matter settled. That has ramifications for the culture of governance in place. This sort of behaviour wasn’t important to the senior management and consequently was not viewed as important by anyone else.”

Whistle while you work

What should the finance director be doing?

Smethurst says the FD should take the lead in establishing a corporate culture where it is clear that there is a zero-tolerance policy towards corruption and fraud. The lead has to come from the top and the zero-tolerance culture has to have a high profile and permeate all areas of business activity.

“I am of the view that it is the manager’s responsibility to have a culture and internal controls in place that mean fraud cannot thrive,” he says.

In terms of practical anti-fraud measures that may be considered, Smethurst says one of the most powerful instruments is the establishment of a fraud hotline that employees, suppliers or customers can use to report inappropriate transactions and suspicions of fraud. The clear message that there will be no repercussions for any internal “whistleblower” must run alongside this culture.

However, Smethurst says it is clear that there is more work to be done in implementing legislation that will protect whistleblowers within UK plc. He points to the largely self-regulating and -reporting regime that is in place, and the vague protections to whistleblowers offered through the government website.

The website states that “if you believe there is malpractice or wrongdoing happening in a workplace then you can ‘blow the whistle’ on the behaviour and you could be protected from losing your job and/or being victimised by your employer”. Smethurst says this does not go far enough in offering assurance.

“‘Could’ – that’s no good at all,” he explains. “It is no accident that fraud and corruption are usually discovered thanks to a whistleblower and, as it furthers a culture that will not tolerate fraud and corruption, improved legislation protecting the whistleblower should be a priority.

“Corporate governance and leadership comes from the top. If you fail in that respect, you can massively undermine your entire organisation. It doesn’t matter what the business model is.”

In the cases of Enron, Worldcom and Arthur Andersen, the breakdown in corporate governance eventually led to the destruction of those companies. While this is unlikely to happen at News Corporation, the crisis has claimed some notable scalps. Rebekah Brooks, chief executive of News International, resigned; News of the World, the UK’s best-selling Sunday newspaper, had to close; and News Corporation’s bid for BSkyB had to be abandoned. With consequences like these, Murdoch’s claim that he doesn’t know just doesn’t cut it. ?