Ethical leadership for finance and accounting professionals

 

Garreth Hanley:
This is INTHEBLACK, a leadership, strategy, and business podcast brought to you by CPA Australia.

Belinda Zohrab McConnell:
Welcome to INTHEBLACK. I'm Belinda Zohrab McConnell, Regulations and Standards lead at CPA Australia.

In today's show we're talking with Brendan O'Connell on professional ethics in accounting and how to do it well. Brendan is an expert in corporate governance, ethics, and accounting, with experience in both academia and industry.

He's a member of the Ethics and Professional Standards Centre of Excellence at CPA Australia and an academic who has done extensive research with over 2,900 citations listed on Google Scholar. His research focuses on corporate scandals and ethical issues. He's also consulted for both governments and corporations. Welcome to INTHEBLACK, Brendan.

Brendan O'Conner:
Thank you, Belinda, and it's great to be here.

Belinda Zohrab McConnell:
Now, you and I have spoken before about our love for a good corporate scandal, but it seems that those large scale ethical failures in business and even outright fraudulent and criminal behaviour might make for interesting podcasts and Netflix series. But what can we learn from them given that such behaviour is often at the extreme end.

Brendan O'Conner:
Okay. Well, Belinda, I think there's some real common lessons, if you like, that flow from corporate scandals, accounting scandals, that sort of thing. And I'll just give you a few of them that from my own knowledge are really apparent. And the first one essentially is an unethical and risk-taking culture at the top of the organisation, something often people refer to as the tone at the top. And I'll give you a couple of examples of where the tone at the top was wrong that have been well-publicised.

The first one relates to a big scandal just before COVID with an American bank called Wells Fargo. And they essentially had a business model, if you like, that was very much top-down. And the leadership of Wells Fargo fostered a very high-pressure sales environment for their staff, which pushed employees to meet quite unrealistic cross-selling targets. And the result of this was a lot of unethical conduct by the employees in trying to actually meet the targets. For example, some of them were convicted of creating unauthorised customer accounts in order to meet the targets, so were fictitious accounts. So the tone at the top there was at fault because the leadership created an environment where achieving targets was the key focus, and they were really difficult targets to achieve. And so in desperation, the staff resorted to that.

And one other one closer to home that I'll give you is with our largest bank, Commonwealth Bank of Australia, where they were involved in an anti-money laundering scandal in 2018. CBA's leadership fostered a complacent culture that prioritised financial success over risk management. And this environment, Belinda, led to significant breaches in anti-money laundering regulations, and they received a record $700 million fine for their breaches. So in both of those cases, you can see tone at the top was a big issue.

Another one is ineffective internal controls and risk management processes. A recent example of that is Macquarie Bank who had a scandal last year involving a trader who conducted over 400 fake commodities trades in their London branch and then was able to conceal the losses from those trades. And a lot of the reason for this occurring was because the trader was able to, I shall, I would imagine, find flaws in their internal controls so that they were allowed to go undetected for a long period of time. Whereas if the internal controls had been stronger, the fraud would've been detected much quicker.

And the last one I'll mention is aggressive earnings management. So when I say earnings management, essentially, Belinda, I'm talking about cooking the books. And we've had a lot of major scandals around cooking the books. And unfortunately, accountants often get blamed for those. Often, it's driven by the senior executives of the organisation. The most famous of those, of course, is the Enron scandal in the US. But a bit closer to home and more recently, there was a scandal like this involving an Australian startup tech company called Big Un Limited in 2018 where the company falsely reported substantial revenue growth and claimed a huge increase in cash revenue.

However, ASIC when they investigated found there were serious flaws in the financial statements revealing actual cash and cash equivalents were much lower than what was reported. And the way they were able to perpetrate the fraud was misrepresenting sales figures and using undisclosed financing arrangements.

So you can see there, Belinda, there's a lot of commonalities there that we need to be cognizant of as an organisation to make sure we don't fall into those traps, which could then lead us down a very bad path.

Belinda Zohrab McConnell:
Yes, yes. Well, thank you. Thank you, Brendan, for all those examples. I was thinking about them. Some of them seem to relate to I guess what we would say the true crime, the money laundering. And then others, like you said, that the cooking, the books, of course, those are breaches of accounting standards. Some other ones though seem to be, I guess, that more nebulous.

I think that's in the ethics space, that idea of leadership and charisma and influence, or even when you were talking about incentives and sales incentives and pressure. So I think what some area that people struggle with is if I'm not committing a crime, why do I need to worry about ethics? Because ethics, our Code of Ethics is not a law, is it?

Brendan O'Conner:
No, it's not. But as professional accountants, we are bound by both our legal and our ethical obligations. And it's very important, Belinda, to recognise that just because something is legal doesn't mean that it's actually ethical. So if we go back to the example I gave before about cooking the books, if you flagrantly violate the accounting standards, then that would be a breach of the law. But if you do it in a more subtle way, for example, take an overly optimistic estimate of a provision or an overly optimistic recognition of a sales revenue, that may not necessarily be technically breaching the accounting standards and therefore illegal, but it nevertheless, if it's motivated by you trying to misrepresent financials performance, then you could argue it's an unethical action.

And as a professional accountant, we're expected to uphold higher standards than the general public. We're not expected just to follow the minimum legal requirements. That's actually the low bar. We're expected to uphold the key ingredients of the code of our ethical conduct, which of course is APES 110 in Australia. And that has the five major principles, fundamental principles, of integrity, objectivity, confidentiality, et cetera. And we need to adhere to those. So it's not just about the minimum which is ingrained in the law. It's about a much higher calling as professional accountants.

And it's also important to recognise that if you do breach the Code, you can be held to account for that. There are various disciplinary committees the accounting bodies have, including CPA Australia, and they can take sanctions against you. So even though the Code of Ethics is not law, it's not optional when it comes to being a professional accountant, and we need to recognise that. So essentially, it's really important for us as professional accountants to be fully aware of both those professional obligations and the laws and to make sure that we behave and do our job consistent with both of those.

Belinda Zohrab McConnell:
Right. So if I was to flip it around and think that being ethical is not just about not doing the wrong thing and not ending up in the paper and not committing obviously a crime or contrary to the standards or being sanctioned by the professional body or a regulator, instead, can I flip it around and say what are some positive ethical actions and activities? And what are some examples of people, I guess, not making, not demonstrating ethical failures but ethical successes?

Brendan O'Conner:
Okay. Yeah, sure. Well, the ethical successes is a really interesting one because often these go unrecognised, but there are some compelling examples out there of businesses here and also overseas that have chosen to act ethically even when they weren't actually legally or professionally required to do so. They just chose to do this. So I'll give you a couple of examples. One close to home is BHP and back in 2017, they took proactive steps to improve their climate risk disclosure and sustainability reporting. And it was actually well ahead of mandatory requirements at the time. So specifically, they began publishing scenario analysis that were aligned with the task force on climate-related financial disclosures. And at that time, that was voluntary to do so.

And why this matters is that they actually front-footed climate risk as a governance and investment issue within their organisation, and that influenced others. So it actually helped to normalise sustainability reporting right across the ASX 200. So today, we see most of the ASX 200 providing quite detailed analysis in their sustainability reports. And BHP at the time were a leader in that area, which was really good to see.

And I'll give you one other example from overseas, which is a company that you may or may not have heard of called Patagonia. Patagonia are a US-based outdoor clothing and gear company. And in 2022, their founder transferred ownership of the company to a trust to ensure all profits from the company in the future would go to fighting climate change. So that's pretty radical. It goes beyond your typical CSR reporting and focus to essentially a values-driven decision with no legal obligation to do so behind it. So maybe that's an extreme example, but it just shows you there are organisations out there that are not just trying to do the right thing, but are really going above and beyond what are expected to do.

Belinda Zohrab McConnell:
Yes, really leading the way and actually affecting change.

Brendan O'Conner:
Absolutely, and they do influence others. So that's the other great thing about it is when peers see these organisations adopt something, it can have very positive influence on what they decide to do.

Belinda Zohrab McConnell:
Now, you've mentioned the Code of Ethics or the Accounting Professional Ethics 110, also affectionately known as APES 110. But I know a lot of people find it very long and very complex, and it's obviously frequently being updated as there are changes to the Code. And I think one of the things which are difficult is that it tends to be the kind of thing you go to when you've had an ethical failure or if you are wondering if something that's gone wrong is a problem. How instead could we use it in a more proactive way to ensure that we are behaving ethically before something goes wrong? How can I use it in a way that makes it less intimidating?

Brendan O'Conner:
Okay, sure. Well, I think by far the most important part of the Code is Part 1 because that sets out the five fundamental principles that I mentioned earlier. And it also gives you a conceptual framework around how to adopt those principles and whether you're at all in danger of actually violating any of those principles.

And that can be used if you like as a framework for your decision-making. So it really in some ways that first section, Part 1, is a practical decision-making tool, and essentially it walks you through it. So you start by identifying the ethical issues using the five fundamental principles, integrity, confidentiality, et cetera. Then you've got to assess the threats to compliance with those principles. So what might the threat might be, for example, it might be a self-interest threat that you might get a personal benefit, or it might be a familiarity threat where you are familiar with the other party because of a personal friendship or relationship or something like that. So you can see there can be these sorts of threats that emerge, conflict of interest. This is of course another one.

And then once you've got those threats to compliance with the principles identified, you can look at applying safeguards to try and eliminate or at least reduce the threat to an acceptable level. So an example of a safeguard you could put in place might be that if there's some apparent conflict of interest, you might get someone to check your calculations, check your work to make sure that it stands up to scrutiny. You may decide to get another colleague to do the work rather than you if you've got that conflict or you might but outsource it. So there are safeguards you can adopt to eliminate or reduce the various threats.

And of course, the biggest probably, shall we say, check and balance on this is using your own professional judgement and where appropriate, consulting with others and documenting your decision-making process. So I'll just give you a couple of examples, hypothetical examples if you like, of how you could apply the Part 1 of the Code to a particular situation.

So let's say you're a financial controller for a listed company and your boss pressures you to recognise revenue from a large contract that hasn't yet been signed. And your understanding of the accounting standard would tell you because it hasn't been signed yet, it shouldn't really be recognised at that point. And so you would obviously have concerns about that. So the first thing you would do would be identify which of the five fundamental principles were at play.

So in this case, integrity would certainly be a concern because you are recognising revenue prematurely, which is misleading. Your objectivity also is in question because you have personal gain here because obviously you don't want to lose your job. Maybe you've got a bonus tied to it, this sort of thing. So your objectivity is potentially impaired. You've got professional behaviour also in question because the proposed action, if you were to mislead investors, is unprofessional behaviour and brings the accounting profession into disrepute. So there's three key ones there. And then you might even throw in due competence and care as well, because you should be preparing the accounts to truly represent the financial situation rather than misrepresent it. So the first thing you'd be doing is you'd be identifying the potential fundamental principle breaches.

Then the next would be talking about what are the threats to the breach? So in this case, the threats probably were self-interest threat and intimidation threat because, one, you can personally benefit from this by keeping your job, getting a bonus, but there's also an intimidation threat there, isn't it? That your boss might be threatening you to do it to such a level that you're intimidated. So then you've got to think about, well, what safeguards can I put in place here?

Well, you can certainly push back on it with your boss and reference the accounting standards and point out to him or her that this is a violation of the accounting standards. And as a professional accountant, you have an obligation to comply with the accounting standards. And in fact, you have a legal obligation too, because a lot of people will forget this, but it's actually a breach of the corporation's law if you violate the accounting standard. So you could point those things out to him or her. You could also, if you're getting nowhere with that, you might refer the matter to another part of the organisation, or say for example, the audit committee of the board of directors or even an external party if you felt it was something that had to go outside of the organisation.

So you can see there, you could work your way through that process. And if the pressure continues, then it's important probably, and this is certainly set out in the Code to document those concerns and then take appropriate action, which might be reporting it under, for example, the NOCLAR provisions. And for those who are not familiar with the NOCLAR provisions, these are the provisions relating to where there is a potential breach of the law. So it could be any particular law, it could be in this case, it's probably going to be the corporation's law, but it could be safety, occupational health and safety laws. It could be environmental laws, whatever particular situation is.

So the NOCLAR provisions are there for all breaches of the law. And what they essentially say is that you cannot turn a blind eye to it. You have to do something about it. And it's really important that you work your way through what options you will take. And if you're getting nowhere within the organisation, then you do have to go external if it's a NOCLAR situation.

So you can see there with that example I've given you that the Code walks you through the way you should approach things. And I think that's really useful as a practical tool, not just as something as you started with a very long document, because it is a long document, but don't forget a lot of that long document may not apply to your situation. For example, if we look at the Code as a whole, we've got parts of the Code relating to particular types of situations an accountant might be employed in.

So for example, if you are working in public practice, then the third part of the Code's very important and relevant to you. But if you're not working in public practise, then you don't really need to know much about Part 3. What you'd probably be looking at is Part 1 and 2 because Part 2 talks about professional accounts in business, which is corporate accountants, management accountants, people working in the not-for-profit sector, et cetera. So that part would be relevant to you. And in the fourth part of the Code is all about auditing. So unless you're involved in auditing, you probably don't need to worry as much about that.

So essentially what I'm saying is Part 1's the most important, underpins everything. So you do need good familiarity with that. And don't think because you studied that 10 years ago in the ethics and governance module of the CPA Program that you need to forget about it now because there's been a lot of changes. Over the last 10 years, it's been quite a few changes, and you need to keep up to date with those changes.

Belinda Zohrab McConnell:
Well, thank you, Brendan. I think that was extremely helpful, particularly to know that the Code is not just a long list of what not to do or rules, but instead it actually provides a framework of the positive steps that somebody can take when they are faced with an ethical dilemma, or even if they're concerned that they might face with one or they anticipate one or they want to avoid encountering one. So I think that's extremely helpful.

And the other thing I found very helpful from this discussion is your comments around how much leadership influences, because the example you just provided of course was very much about a leadership and, I guess, a subordinate relationship and how that dominance, and whether it's characterised in whatever way in fact, but can have such an impact. And so thank you very, very much. I found that very interesting. And there's much more we could delve into, but we'll have to wrap up there. So thank you very much for joining us today.

Brendan O'Conner:
My pleasure, Belinda, and I hope everyone found that useful.

Belinda Zohrab McConnell:
And thank you for listening to INTHEBLACK. Don't forget to check the show notes for links and resources from CPA Australia. If you liked this show, please share it with friends and colleagues and hit the subscribe button so you don't miss future episodes. Until next time, thanks for listening.

Garreth Hanley:
To find out more about our other podcasts, check out the show notes for this episode, and we hope you can join us again next time for another episode of INTHEBLACK.