Non-Executive Directors: Being Prepared For The ‘Unexpected’

NEDs could be forgiven for feeling that they continually have to be on their guard against the unexpected (Black Swan) event which could come out of the blue at any point

In terms of assessing potential risks, it is important for boards (and particularly NEDs) to consider all of the circumstances, including the cultural and environmental angles, which may be more likely to lead to these issues arising, not least as some may not be as unlikely as they first appear. This article suggests some areas which NEDs may wish to consider based on recent examples and also offers some suggestions as to how to address any issues identified.

Areas to review: Do any of the following apply to the business?

We set out below some (maybe not so) obvious questions to look at:

• Has the management team been in place for a long period? Could the business have become complacent in retaining methodologies which are no longer appropriate and does it need to look at ways of refreshing its approach?
• Does it enter into long-term contracts? If so, the pricing strategy for those contracts should be reviewed in detail on a regular basis. In addition, regular review of the revenue and cost recognition policies and how those are implemented should be undertaken. It should also be considered whether any of the contracts are in areas which are new to the group so may not have the requisite experience to manage and/or price effectively.
• Is it an acquisitive group? The effectiveness of integration of people, finances, systems and culture should be reviewed regularly.
• Has it grown rapidly either organically or through acquisition? This may suggest that the management or systems are no longer appropriate for the increased scale of the group.
• Are there any issues with the financial reporting? The internal and external audit functions should be challenged to highlight any issues which they identify and/or where they are unable to get a satisfactory response from management or where they do not agree with the response received.
• Is the board’s access to non-board members limited? This should be avoided so that board members can validate information received from executive management on the board.
• Is there a domineering CEO? He/she may be a strong driver of the business but may also be developing a culture where people do what is expected, and not necessarily what is right.
• Has there been a high level of employee churn and/or a low incidence of whistleblowing? This may be indicative of a bullying culture.
• Are questions from the NEDs dismissed or brushed off (for example, based on the greater knowledge and experience of the management team)? It is important for NEDs to understand the businesses which they are on the boards of and that may involve asking what management regard as “obvious” questions.

What to do when an issue develops

The list of companies who have had “unexpected” problems (of different scale and severity) over recent years is growing, as is the spectrum of sectors affected : BT, Capita, Carillion, Conviviality, MITIE, Redcentric, Serco, Telit, Tesco to name but a few. It is critical that the company is in a position to respond in the (hopefully unlikely) event of one of these issues arising.

The company should ensure that it knows how it would handle an unexpected situation and address the following questions:

• Who would lead the process: the board as a whole, a sub-committee, role of the NEDs?
• How would the issue be investigated thoroughly and expeditiously?
  
• What advisers would the company turn to?
• Are there likely to be any incoming or outgoing claims? If so, ensure that a suitable legal privilege arrangement is put in place around any investigation and/or documents created
• How will the company ensure that it has complied with its MAR and other announcement obligations?
• What preparations need to be put in place to ensure that the company is prepared for any incoming regulatory inquiry?