Dear reader,

Welcome to the November 2013 edition of The Director’s Dilemma. To read this email in your browser, go to www.mclellan.com.au/newsletter.html and click on ‘read the current issue’. 

This month we have details of a new course on establishing boards for entrepreneurial companies, a book review, some research into the total costs of boards, and, of course, an original case study drawn from a true life situation. November’s case study concerns how a chairman and board might address a situation created by their predecessors but which has the potential to destabilise the company and discredit both board and shareholders.

Consider: What would you advise a friend to do under these circumstances?

Brian is chairman of a government owned company. Succession has been ‘actively managed’ with directors rotating on and off the board. This has given access to new skills including marketing and modern media but has resulted in a board with relatively little corporate history. Brian is the longest serving member and has only been on the board for five years.

Six years ago the company terminated the employment of the then CFO due to allegations of improper accounting which had resulted in revalued assets and a large profit being declared in the prior year triggering  payment of bonuses to the then CFO and CEO.

The former CEO left shortly after receiving the bonus. The replacement CEO decided to investigate the accounting treatment. The investigation was conducted by the outsourced internal audit firm and concluded that the accounting treatment did not meet guidelines or even generally accepted accounting standards. The statutory auditors agreed. The asset revaluations were subsequently reversed which led to a large loss, no dividends or tax equivalent payments that year, and great embarrassment.

The former CFO was terminated and the matter referred to the police as a possible fraud. A new CFO was appointed. She is a pleasant and efficient person whom the board like and respect. She is considered a potential successor to the current CEO. The police decided not to pursue the fraud allegations as they believed these lacked sufficient evidence. The former CFO is suing for wrongful dismissal, the lawyers believe he may win, and the current CFO is worried because the union is calling for the former CFO to be reinstated.

The board is looking to Brian, who also chairs the remuneration committee, for guidance on what to do. The current CEO has offered his resignation but nobody wants to accept it.

How can Brian help the board to move forward?

Brian must lead the agenda to resolve the former CFO’s claim and to allow the Board to refocus on governance of the organisation. The CEO should be told right away that he has the Board’s support and his resignation will not be accepted, and the CFO should be reassured likewise.

Next the relevant Government stakeholders must be briefed. Briefings under conditions of legal professional privilege must go to the Government department, responsible Minister, and insurers, and should include a background, current assessment of the legal claim, possible downsides, as well as the communications protocols. Brian should direct management to prepare this brief and the Board should review and approve.

Legal advisers will provide downside scenarios which may unsettle.  The Board should receive an independent, detailed, current diagnosis of the claim - the causes and process for the termination, termination terms and conditions, and an assessment of the merits of today’s claim. Management should retain senior legal advice for the Board (probably at the level of Senior or Queen’s Counsel) and forensic accounting/fraud experts might review the prior improper actions leading to termination. 

While the Board might be advised the past termination process was proper and justifiable, it is always possible a court process may find it was not. Brian and the Board should walk a fine line between allowing a judicial process to take its course and vigorously protecting the organisation. Brian should expect that a mediation or arbitration process will emerge (either directed by the Court or at the instigation of the claimant) and the Board’s role will then be to receive proper advice and to approve negotiation parameters. These might include stonewalling the claimant all the way to court, or acceptance that monetary compensation is payable. As six years has passed there is only a faint possibility that court will order reinstatement - sometimes Humpty Dumpty cannot be put back together again.

Throughout Brian must settle the Board and the current CFO and CEO. The organisation’s purpose is much more important than a previously terminated employee’s action and a past issue.  The Chair should discuss with the Board whether the full Board will participate or whether a subcommittee (two or three) should receive appropriately devolved powers to oversee and approve actions. Either way Brian should use the processes to pull the Board together and to grow its capability. It is just these moments that mature a Board into a cohesive whole.

Nigel Poole is a Strategic Adviser at Australia’s national science agency CSIRO (Commonwealth Industrial Research Organisation). He is based in Sydney.

Asset valuations are as much an art as a science. In a government owned corporation assets frequently produce revenue streams that do not reflect their true monopolistic essential-service value-in-use and there are few alternative owners to establish a market value; the directors must use judgement to ascertain a value. It is the board that certifies the value of the assets to the auditor, not the other way around.

The board, at the time of any substantial revaluation, should have held meetings and produced minutes which will help Brian and his fellow directors to understand what was thought at the time.

Irrespective of whether those thoughts are now held to be correct it is important to establish that a due process was used for such an important determination. This is especially true when people’s reputations and careers are affected by board’s decision.

Brian’s board must decide on the current value of the assets and talk with both Treasury and the relevant Minister to ensure that the value in today’s accounts is accepted by both these stakeholders.

Court cases are always dangerous. The result is never a forgone conclusion. Each case depends on the precise pleadings and legal strategies employed by the participants. Brian must discuss with his board and legal counsel the potential outcomes and also the possibility of a negotiated settlement. Settlements are often cheaper and less embarrassing for all concerned. Depending on the degree of emotional hurt that has been caused it may still be possible to reach a settlement and it would be worth talking with the former CFO to find out what he could feel was an acceptable resolution.

The current CEO is not to blame. A new incumbent in that role would investigate any large variations to asset values as part of due diligence, especially if there had been controversy about the values. Brian should reassure him that the board does not want his resignation but does want his support in resolving this issue. Both Brian and the CEO should attest their support of the new CFO; this is not a pleasant situation for her and she has done nothing to create it.

Once the board has a preferred strategy then Brian should communicate this to the relevant Ministers and manage any concerns they may have. He could also usefully have a meeting with the union leaders and seek to understand their interest in the matter. Above all Brian must gather information, use it wisely and become a trusted participant in the resolution of this matter.

Julie Garland McLellan is a practising non-executive director and board consultant based in Sydney, Australia.

Any good Remuneration Committee Chair will seek the guidance of independent expert advice, so my first bit of advice to Brian is to get second opinions on the ex-CFO's claim against the company and the legitimacy of the payment of bonuses given the false accounting (there is likely to be a bit of precedent here given the recent global accounting scandals of similar ilk).

If the answers to this dilemma are not immediately obvious to the Committee, it should look at the processes, scenarios and steps that would achieve the best outcome for the organisation and develop Plans A, B & C to report the options back to the Board. Part of this should look at key-man and talent retention risks because it sounds like they don't want to lose their current CEO or CFO.

The Audit Committee might also consider how the improper revaluations slipped past the Auditor General of the time, or the outsourced External Auditor that signed-off on the accounting treatments (is there a possible claim against the AG or the outsourced EA?). Restoring confidence will also mean ensuring that it can't happen again. The stakeholder engagement with the shareholding ministers' department and the interested Union should also be considered as part of this planning.

There are probably other considerations (including ensuring that new Directors don't get spooked off the Board fearing reputational tarnishing despite being appointed subsequent to the irregularities), but this might be a good start for Brian.

Michael Rich is a director of Blackhall and Pearl. He is based in Melbourne, Australia.

The opinions expressed above are general in nature and are designed to help you to develop your judgement as a director. They are not a definitive legal ruling. Names and some circumstances in the case study have been changed to ensure anonymity. Contributors to this newsletter comment in the context of their own jurisdiction; readers should check their local laws and regulations as they may be very different.

Entrepreneurial Boards, when should you form one, who should you invite to join, and how can you get value from it? - Join me for an interactive and insightful lunch-time course focused on the real dilemmas facing entrepreneurs as they approach the important task of building boards for fast growing companies. The course is on 3 December in Sydney. Click here for more information.

Book review - Power Up Your Productivity by Michael Atlas. We have all sat at boardroom tables with directors who seem to have the uncanny knack of picking the important issues and focusing on the critical levers for success. They are also usually the ones who manage a seemingly impossible workload with grace and humour. This book goes some way to describing how they do it! The book covers everything from personal fitness, through individual productivity techniques to networking and decision-making and is a good resource for any director who is finding life just a bit too busy for comfort. Available at amazon.com

Inspirational quote -

I have subscribed to a service that delivers an inspirational quote every day. It is a good way to get into a positive frame of mind for the work day ahead. I thought I would share my favourite quote each month. This month my favourite quote was:

"When everything seems to be going against you, remember that the airplane takes off against the wind, not with it."
~Henry Ford

Perhaps I have had a tough month but this quote rang true for me when I read it. Fortunately I am now flying again rather than battling headwinds and I hope you will be similarly confident of progress and success.

If you would like to subscribe the service is run by Darren La Croix at: https://365inspirationalquotes.com/.

The real cost of your board - Research from the USA and Europe suggests that CEOs and their direct reports spend up to thirty percent of their time supporting the Board. This work includes researching and writing papers, briefing directors, preparing minutes and agendas, attending meetings and answering questions. I was keen to understand more about the board-management interface in Australia to see whether the same applies. Read the preliminary research findings here.

This newsletter - If you have any ideas for improving the newsletter please let me know. If you are reading a forwarded copy please visit my website and sign up for your own subscription.

Suggestions for dilemmas - Thank you to all the readers who have suggested dilemmas. I will answer them all eventually.

Personal note - Thank you to all the people who have been so understanding that I am unwell at the moment and unable to do much more than keep up with my current commitments. I now have a diagnosis and treatment; I’ll be back to my usual energetic self in a few weeks and look forward to resuming my usual workload.

Farewell until the next issue (due 1 December 2013).
Enjoy governing your corporations; we are privileged to do what we do!

Best regards,
Julie