By Professor Guido Palazzo, Academic Director at Executive Education HEC Lausanne
Amid all the financial, logistical and operational pressures the pandemic has piled on business, it’s easy to overlook the fact that periods of crisis are also the breeding ground for fraud and corporate wrongdoing.
As a recent report from the Association of Certified Fraud Examiners (ACFE) put it, these pressures “open the door to the increased pressure, opportunity, and rationalization that can lead to fraud”.
A survey for the report found that 68 per cent of anti-fraud professionals have experienced or observed an increase in fraud levels during the pandemic and almost all expect to see an increase in fraud over the next 12 months, with half expecting this increase to be significant.
For financial directors and compliance professionals, this increased risk demands a new and different focus on compliance. Because for every Enron-scale scandal that hits the headlines, there are many more lower-profile cases.
And despite all the policies, codes of conduct, training sessions and formal processes, they keep happening. And that raises the question as to whether our compliance strategies are really fit for purpose or could they be more effective at tackling unethical decision-making and fraud.
Scandals such as Enron, Volkswagen and Siemens demonstrate that, even people with a high level of integrity, can become rule-breakers, driven by psychological forces that distort organisational cultures and push them towards the dark side.
And while rules, mitigation measures and regulations are very important tools, they do nothing to control context so that good people are not tempted to do bad things.
In other words, the focus on the legal dimension of compliance and risk management has led most organisations to systematically underestimate the role of human psychology in mitigating risk. If it is to be more effective, compliance needs to be more proactive and more holistically integrated into the organisation.
That means compliance and finance professionals developing new skills that recognise the vital role of this human element. Here are some of the factors they need to consider.
Understand ‘ethical blindness’
If you made a list of the character traits of people involved in wrongdoing and corporate scandals, you might be surprised to find just how like the rest of us they are. But if you put sufficient pressure on average people, two things will happen.
First, fear will kick in because they realise that what they’re doing is wrong. But then they start to rationalise their actions to justify what they are doing and over time, such behaviour becomes normalised.
This phenomenon is something we have termed ‘ethical blindness, and understanding how and why it affects individuals is key to addressing the problem of systematic organisational wrongdoing.
The antidote to ethical blindness is to create a culture in which people feel able to speak up against bad practice early, one that encourages debate and diverse viewpoints and does not close ranks to shoot down any challenge to the status quo.
But critically, if senior people in the organisation don’t speak up, other staff won’t do so either, so it’s essential that the tone is set from the top. The key question to ask is whether individuals feel able to speak up to their superiors without fear of retaliation and whether the same is true at all levels of the organisation.
Blind spots and warning signs
Pro-active compliance is about analysing organisational contexts for weak indicators of human risks. Many large-scale scandals could have been nipped in the bud if compliance managers had been able to see the warning signs earlier.
These small signals viewed in isolation may seem insignificant, but over time they can combine to create a dysfunctional culture where it can be all too easy for people to slip into the dark side. Understanding the psychological and emotional factors behind human risk can wave red flags long before real problems emerge.
In order to identify and analyse behavioural compliance risks from both a structural and psychological point of view, compliance professionals need to embrace what I call ‘integrative ethics and compliance’.
This means training to understand theimpact of social context on decision-making using different theories (management, psychology, etc), to assess the degree of risk for ethical blindness in organisations. When you start to embrace these other dimensions, compliance becomes a leadership topic and moves to centre stage in the decision-making processes.
The application of the rules is often much more complicated than their definition. In a world filled with grey areas, risk and compliance professionals need to know how to handle difficult and real compliance situations, from how a sales manager can say ‘no’ to a customer who asks for a bribe to how a compliance officer should effectively interview an employee in an investigation.
A strictly legal approach to compliance may be effective against the small number of real criminals who intentionally break the rules, but dealing with the ‘messy middle’ and its shifting cultural and contextual patterns demands more than that. Simply removing ‘bad apples’ is all very well, but it does nothing to disinfect the barrel for the new apples that are coming in.
Read the full findings here