Ethics and BP: Corporate Governance - Part 2

Delegation of Duty
For boards to effectively carryout these strategies they must delegate to the CEO, who in turn delegates to other senior management the authority to manage the day-to-day affairs of the corporation. Although the board delegates authority to oversee the day-to-day operations, the board is still responsible for monitoring of management on behalf of the shareholders (Vallabhaneni, 2008).

According to Vallabhaneni (2008), senior management is charged with the following tasks: (i) Operating the Corporation; (ii) Strategic Planning; (iii) Annual Operating Plans and Budgets; (iv) Selecting Qualified Management and Establishing an Effective Organizational Structure; (v) Identifying and Managing Risk; and (vi) Accurate and Transparent Financial Reporting and Disclosures. BP has policies in place that meet these tasks; making a better corporate governance program. BP’s policy matching Vallabhaneni’s tasks were taken from BP’s Board Governance Principles and Annual Report and Accounts 2009 as shown below (BP p.l.c.) (Svanberg, 2009).

(a) Operating the Corporation - The Board delegates its authority for the executive management of BP to the Group Chief Executive subject to the defined limits and monitoring by the Board and all GCE actions must be carried out and practiced in a professional and ethical manner;

(b) Strategic Planning - The GCE is authorized to establish any policy, make any decision, enter into any obligation, take any action and develop any activity that will achieve the BP Goal and which is within a reasonable interpretation of the Executive Limitations;

(c) Annual Operating Plans and Budgets - The GCE will propose for Board consideration, the GCE’s Strategy for achieving the BP Goal. Annually the GCE will propose the Plan together with specific results to be achieved during the financial year in pursuit of the BP Goal;

(d) Selecting Qualified Management and Establishing an Effective Organizational Structure - Not directly addressed within BP’s Board Governance Principles;

(e) Identifying and Managing Risk - The GCE will not cause or permit BP to operate without a comprehensive system of controls that manages the risks to protect BP’s assets;

(f) Accurate and Transparent Financial Reporting and Disclosures - The GCE will not cause or permit BP to operate in a manner which would or would be likely, to result in BP becoming financially distressed.

Occupational Fraud

Finding effectiveness in the boardroom has emerged as a popular topic after the financial collapse of, once highly regarded, corporations like those of Enron, Tyco and Adelphia. Finding effectiveness may sound like an easy task to accomplish, however, in today’s complex corporations there are far too many variables to identify, monitor, and measure when assessing effectiveness. Carolyn Iglesias (2008) states, “The absence of a universal model for effective board governance creates a significant challenge, and companies often find it difficult to know where to start.” Michael Ross (2008) makes note that effective directors are those who take their fraud-detection responsibility seriously and focus on fraud’s telltale “red flags.” DiNapoli describes “red flags” as, “a set of circumstances that are unusual in nature or vary from the normal activity.” Directors should not solely focus on the identification of red flags, they should focus on identifing “effective red flags.” Thus, improving the effectiveness of red flags should lead to a more effective boardroom.

The Association of Certified Fraud Examiners (ACFE) defines Occupational Fraud as, “The use of one’s occupation for personal enrichment through the deliberate misuse or misapplication of the employing organization’s resources or assets.” Preventing Occupational Fraud can save organizations a substantial amount of revenue; an estimated 5% of an organizations’ annual revenue is lost to fraud in a given year. The median loss across all fraud schemes were reported to be $160,000, one-third reported a loss of more than $500,000 and one-quarter reported losses of $1,000,000 or more (ACFE, 2010). Organizations engaging in fraudulent activities often suffer from long-term consequences. An analysis of U.S. Public Companies, conducted by the Committee of Sponsoring Organization of the Treadway Commission (COSO) indicates corporate fraud often leads to bankruptcy, delisting from a stock exchange, and an average initial drop of 16.7 percent in stock prices after an alleged fraud makes it to the press. Of course this is not a complete list of the consequences of fraudulent activities; only a small sample is necessary to recognize the devastation that fraud can have on an organization (COSO, 2010).

Cressey’s Fraud Triangle

Corporations looking to mitigate the damages caused by fraudulent activities must first understand the psychology of fraudsters. The importance in identifying the motives of criminals committing these fraudulent acts is in the ability to devise initiatives to prevent, deter, or stop occupational fraud from occurring. While working on his PH.D in criminology at Indiana University, Donald Cressey’s hypothesis became, what is now known as, the Fraud Triangle. Dr. Cressey’s Fraud Triangle highlights three elements that must be present in order for fraud to occur: Opportunity, Incentive (Pressure), and Rationalization (Wells, 2008).

The first element of the fraud triangle is opportunity, which occurs when an individual has the ability to commit a fraudulent activity. According to Joseph T. Wells (2008), opportunity can be broken down into two separate parts: general information and technical skill. General information is, knowing that a fraud can be carried out and technical skill is the ability to execute the fraud. The second element, Incentive (Pressure), can occur when an individual: (i) feels pressure to keep a certain social status, (ii) feels pressure to keep up with peers at work, or (iii) incur a financial burden that must be alleviated. The third element, Rationalization, is the justification of the crime that the perpetrator wishes to attempt. The fraudster might feel like their employer owes them something, justifying their position as not being a criminal. If we can eliminate any one of these three elements, theoretically we will stop the fraud from occurring.

Effectiveness of Red Flags

According to the ACFE (2010), the top four effective detection methods for identifying fraud schemes are: Tip, Internal Audit, Management Review, and Account Reconciliation. Notice the absence of External Audits from the ACFE list; external audits are important, but they should not be relied upon exclusively for fraud detection (ACFE, 2010). If we are not to rely on external sources for fraud detection, it becomes important that management and employee receive red flag training to better understand the red flags in their area of expertise.

Most red flags dealing with fraudulent activity are categorized as employee or management red flags. Employees commit fraud on a more frequent basis (41.2%), however fraud conducted by management was three times as costly ($218,000) then those perpetrated by employees (DiNapoli, 2010).

Red flags should be built around all three elements of the fraud triangle. Risk assessments should be conducted to establish areas of high risk for fraud. Once these “opportunities” are identified you can start building roles that identify those with the technical ability or in trusted positions to perpetrate the fraud scheme. These roles can then be monitored for behavioral red flags indicating an elevated rate for fraudulent activities to occur. The effectiveness of red flags depends upon the effectiveness of those who identify, monitor, and measure red flags.

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